This is a great post Nikhil - I think another force driving specialization in the VC model is the rise of strategic LPs who bring differentiation to GPs. Google has created a family of funds (GV, Capital G, and Gradient) that represent sector specialization and stage specialization. Sapphire (SAP) and M12 (Microsoft) have also emerged as relevant sector specialists and stage specialists in the ecosystem in a short period of time. Our firm, Decibel (Cisco), is purely focused on B2B software at the earliest stage and is investing heavily in services to help founders. The VC industry is now >50 years old - I think all of the innovation going forward is not in how we invest in companies but in how we differentiate what we do to help startups grow.
Thanks for sharing your thoughts. Another way to evaluate the specialist to agglomerator migration as well as the emergence of microfunds at the seed stage is through the lens of Christensen's Disruption Theory. The desire and need for growth (represented by growth in AuM) drives this migration and is difficult to resist. The same argument can be made for the angel -> super angels -> SPVs migration that you mentioned in the previous post. One way to address this urge for AuM growth is to limit growth in team size which makes it easier to stay a specialist without worrying about how to meet the team's career progression needs. And if you do go the agglomerator route, you can remain competitive (and generate great returns) if you 1. align incentives across both the investment and portfolio support team in a way that each sub-fund can invest and support portfolio companies independent of the other funds and 2. make sure that the value you provide to the entrepreneurs who take the smaller checks get the level of support they expect from a strong brand in the market. Obviously, all these suggestions are easy to recommend and difficult to execute on so it will be interesting to see how the market evolves.
Great article! Nice way to think about VC as a competitive market and as a product.
But if the smartest "agglomerator" VC firms all know that competition is for losers, how are they going to beat the market over the next 10 years?
One thing that very few people talk about is what happens to an industry that has grown 10x+ over the last 10 years, with a limitation on market cap size & trillions of illiquid assets locked up, with pressure building for liquidity?
To get the answers, you have to stop, take a step back and LOOK UP!
Q: What do a16z, Foundry Group & General Catalyst all have in common?
A: They are all registered investment advisors (RIAs). None of these firms are legally venture capital funds.
It seems like the biggest names in VC are trying to transcend the industry.
Take a16z for example. After investing a significant chunk into Carta, which is building the financial railways for Startups and Investors, and then backing LTSE, which is now the 13th registered public exchange, where do you think a16z is headed?
Or what about the former investment banker/retiring VC who thinks the financial gatekeepers to our public markets are crooks? Where are these investors making their next generational or at least decade-long bets?
Maybe horizontally in non-traditional VC markets like crypto, but also maybe vertically, punching a hole in the roof and creating their own signal and delivery channel to the public markets.
It's about democratizing one of the last elitist refuges in the capital markets.
That's where i believe things are headed. To the public markets, by backdoor access only.
Nicely done. We have seen these patterns before and the lesson of time is that as the 'establishment' migrates north in fund size and scope a gap opens. In recent years that led to the emergence of the seed fund as a sector. Now that we have your specialists broadening the market beneath the agglomerators we can expect to once again see a gap emerge at the early-stage of venture funding. Fund-based models tend to have an inescapable imperative towards increasing AuM, as you observed. While one can contain that with a specialist model it remains a driving force for multiple funds.
This time though the gap might be more of a vertical than a horizontal. The aggressive nature of the VC model (series after series) does not treat earlier investors (or most founders) well and the system is already fatiguing that investor group.
Consider the role of the Angel groups. Mostly non-profit collectives of highly skilled and experienced business people with a passion and purpose-driven engagement to align themselves with founders. Those investors support at least 50 times as many companies each year as the VCs so assuming a VC pipeline model is simply not rational, or practical.
All of my best returns have been from companies that never took VC funding and all of my worst experiences have been with companies that did take VC funding. I wonder if this time around we are seeing not just a fragmentation within the VC community but, a more profound division of the industry into parallel segments. The Angel style of investment is certainly more aligned with the growth of for-purpose, self-funded growth ventures that don't need the deep pockets of the consumer retail type ventures so popular with VC in recent years.
Great article, Nikhil. I think there are a few additional elements here that I think can be helpful to consider:
1. Rise of corporate VCs and what role corporate VCs have played both in terms of bringing capital as well as increasing valuations as corporate VCs are less focused on financial returns.
3. Secondary funds or fund of funds such as Industry Ventures are raising funds that are making direct investments in primary and secondary rounds as well as VC fund investments. SVB has also been making direct investments in certain cases.
4. Sovereign wealth funds such as Mubadala, PIF are also making both direct investments in late-stage rounds as well as FoF investments.
Good stuff! A related Q I’ve puzzled over is whether the proliferation of open source and React are going to allow more tiny companies like Notion (about 20 employees at fundraising iirc) to be built by a new breed of Manager/Developers (think Patrick Collison or Tobi Lutke) who prefer to minimize time spent building VC relations and maximize time spent on product? That trend would seem to favor “Solo Capitalists,” insomuch as they can find and appeal to such Founders.
Increasing move to remote would also reinforce this kind of trend, since much VC success traditionally depends on relationships->location.
I love the 2x2. Bottom-right quad feels like the only group that is structurally aligned with durable partnership-relationships, the people who will be there to help you succeed in the long run (vs. cut and run), and know your domain well enough to contribute meaningfully to addressing the hard challenges.
Very nice perspective Nikhil. Being involved with enterprise software start-ups (somehow b2b doesn't sound the right phrase to me) for a while, it looks like the need for specialiZation is very clear.. Be it be the understanding of the business processes. The cost structures.. Need for different types of funding not just equity.. Ability to work with the ecosystem to help make relevant changes in the value chain so and so forth.. Also experience in one geography maynot necessarily be an advantage.. Let alone a vector of scale.. Helping build products for consistency, Efficiencies and relaibility are specialisations that add / create immense value to the enterprise (or b2b) start-ups.. If you follow cricket it is a test match...
Do you think the agglomerators, due to raising large funds, become less well suited for early stage investing (ironically where many of them started). Founders are warned about signaling risks if an agglomerator chooses not to invest in later rounds, and GP attention will be where largest $$s are invested.
This is a great post Nikhil - I think another force driving specialization in the VC model is the rise of strategic LPs who bring differentiation to GPs. Google has created a family of funds (GV, Capital G, and Gradient) that represent sector specialization and stage specialization. Sapphire (SAP) and M12 (Microsoft) have also emerged as relevant sector specialists and stage specialists in the ecosystem in a short period of time. Our firm, Decibel (Cisco), is purely focused on B2B software at the earliest stage and is investing heavily in services to help founders. The VC industry is now >50 years old - I think all of the innovation going forward is not in how we invest in companies but in how we differentiate what we do to help startups grow.
Thanks for sharing your thoughts. Another way to evaluate the specialist to agglomerator migration as well as the emergence of microfunds at the seed stage is through the lens of Christensen's Disruption Theory. The desire and need for growth (represented by growth in AuM) drives this migration and is difficult to resist. The same argument can be made for the angel -> super angels -> SPVs migration that you mentioned in the previous post. One way to address this urge for AuM growth is to limit growth in team size which makes it easier to stay a specialist without worrying about how to meet the team's career progression needs. And if you do go the agglomerator route, you can remain competitive (and generate great returns) if you 1. align incentives across both the investment and portfolio support team in a way that each sub-fund can invest and support portfolio companies independent of the other funds and 2. make sure that the value you provide to the entrepreneurs who take the smaller checks get the level of support they expect from a strong brand in the market. Obviously, all these suggestions are easy to recommend and difficult to execute on so it will be interesting to see how the market evolves.
Great article! Nice way to think about VC as a competitive market and as a product.
But if the smartest "agglomerator" VC firms all know that competition is for losers, how are they going to beat the market over the next 10 years?
One thing that very few people talk about is what happens to an industry that has grown 10x+ over the last 10 years, with a limitation on market cap size & trillions of illiquid assets locked up, with pressure building for liquidity?
To get the answers, you have to stop, take a step back and LOOK UP!
Q: What do a16z, Foundry Group & General Catalyst all have in common?
A: They are all registered investment advisors (RIAs). None of these firms are legally venture capital funds.
It seems like the biggest names in VC are trying to transcend the industry.
Take a16z for example. After investing a significant chunk into Carta, which is building the financial railways for Startups and Investors, and then backing LTSE, which is now the 13th registered public exchange, where do you think a16z is headed?
Or what about the former investment banker/retiring VC who thinks the financial gatekeepers to our public markets are crooks? Where are these investors making their next generational or at least decade-long bets?
Maybe horizontally in non-traditional VC markets like crypto, but also maybe vertically, punching a hole in the roof and creating their own signal and delivery channel to the public markets.
It's about democratizing one of the last elitist refuges in the capital markets.
That's where i believe things are headed. To the public markets, by backdoor access only.
Nicely done. We have seen these patterns before and the lesson of time is that as the 'establishment' migrates north in fund size and scope a gap opens. In recent years that led to the emergence of the seed fund as a sector. Now that we have your specialists broadening the market beneath the agglomerators we can expect to once again see a gap emerge at the early-stage of venture funding. Fund-based models tend to have an inescapable imperative towards increasing AuM, as you observed. While one can contain that with a specialist model it remains a driving force for multiple funds.
This time though the gap might be more of a vertical than a horizontal. The aggressive nature of the VC model (series after series) does not treat earlier investors (or most founders) well and the system is already fatiguing that investor group.
Consider the role of the Angel groups. Mostly non-profit collectives of highly skilled and experienced business people with a passion and purpose-driven engagement to align themselves with founders. Those investors support at least 50 times as many companies each year as the VCs so assuming a VC pipeline model is simply not rational, or practical.
All of my best returns have been from companies that never took VC funding and all of my worst experiences have been with companies that did take VC funding. I wonder if this time around we are seeing not just a fragmentation within the VC community but, a more profound division of the industry into parallel segments. The Angel style of investment is certainly more aligned with the growth of for-purpose, self-funded growth ventures that don't need the deep pockets of the consumer retail type ventures so popular with VC in recent years.
Great article, Nikhil. I think there are a few additional elements here that I think can be helpful to consider:
1. Rise of corporate VCs and what role corporate VCs have played both in terms of bringing capital as well as increasing valuations as corporate VCs are less focused on financial returns.
2. Increasing investments from Family Offices - There are more than 1000+ family offices who are making direct investments or co-investing as a syndicate with other family offices as well as investing in other VC funds along with co-investing rights in their best deals - https://www.bloomberg.com/news/articles/2019-10-31/billionaire-families-reshape-silicon-valley-s-venture-terrain
3. Secondary funds or fund of funds such as Industry Ventures are raising funds that are making direct investments in primary and secondary rounds as well as VC fund investments. SVB has also been making direct investments in certain cases.
4. Sovereign wealth funds such as Mubadala, PIF are also making both direct investments in late-stage rounds as well as FoF investments.
Really well done!
Good stuff! A related Q I’ve puzzled over is whether the proliferation of open source and React are going to allow more tiny companies like Notion (about 20 employees at fundraising iirc) to be built by a new breed of Manager/Developers (think Patrick Collison or Tobi Lutke) who prefer to minimize time spent building VC relations and maximize time spent on product? That trend would seem to favor “Solo Capitalists,” insomuch as they can find and appeal to such Founders.
Increasing move to remote would also reinforce this kind of trend, since much VC success traditionally depends on relationships->location.
I love the 2x2. Bottom-right quad feels like the only group that is structurally aligned with durable partnership-relationships, the people who will be there to help you succeed in the long run (vs. cut and run), and know your domain well enough to contribute meaningfully to addressing the hard challenges.
Very nice perspective Nikhil. Being involved with enterprise software start-ups (somehow b2b doesn't sound the right phrase to me) for a while, it looks like the need for specialiZation is very clear.. Be it be the understanding of the business processes. The cost structures.. Need for different types of funding not just equity.. Ability to work with the ecosystem to help make relevant changes in the value chain so and so forth.. Also experience in one geography maynot necessarily be an advantage.. Let alone a vector of scale.. Helping build products for consistency, Efficiencies and relaibility are specialisations that add / create immense value to the enterprise (or b2b) start-ups.. If you follow cricket it is a test match...
Do you think the agglomerators, due to raising large funds, become less well suited for early stage investing (ironically where many of them started). Founders are warned about signaling risks if an agglomerator chooses not to invest in later rounds, and GP attention will be where largest $$s are invested.