The venture capital industry is downsizing toward smaller and fewer funds. What should the remaining VCs do? What should new VCs do? The answers will have a large influence on entrepreneurs, innovation, and wealth creation.
Venture Capitalists Who Raise Money Now Will Win Later
In the current environment, raising money is tough, not just for entrepreneurs but also for venture funds. Limited partners are cautious about opening their wallets. But this is the best time to raise money. Just like startups who can get money from VCs, VCs who can convince limited partners to fork over money will set themselves apart from the pack going forward. This is because few venture funds are raising large sums of money these days. When things get better, VCs who can amass cash now will be well positioned to invest later.
This raises the question of what strategies VCs should follow to raise their returns and drive innovation.
Less Risk, Lower Returns?
One school of thought argues that VCs should put their money into lower risk ventures. This means companies that have revenues, or at least something that is clearly monetizable. For internet, Web 2.0 and social media plays, mere eyeballs probably aren’t going to do it any longer.
More and more VCs are moving toward later stage companies and avoiding the seed rounds. This means that entrepreneurs are increasingly turning to angels and bootstrapping by necessity to launch their startups.
A variation of the lower risk, lower returns strategy is to grow early stage companies and sell them to “secondary” investors. In this scenario, the VC passes the baton to an investor better equipped to nurture more mature companies that might not be ripe for acquisition or an IPO. This approach mitigates the associated with trying to take a company public. Instead, the VC takes its gains and gets out before the difficulties of scaling the company hit full force. The tradeoff is lower, but more certain, returns to the VC and the limited partners.
Smaller Bets, Higher Returns?
One new VC fund, Andresseen Horowitz, has pegged its strategy on putting smaller bets — as small as $50,000 — on startups. Andresseen Horowitz operates on the premise that small funds placing small bets on will enjoy higher returns. I guess a $300 million fund is small these days.
The firm pitches itself as a “super angel.” However, unlike most angels who closely control and manage their investments, Andreessen Horowitz plans to invest in a large number of companies (70 to 80 at a time), take a hands-off approach and increase its investment in the winning companies.
The Ecosystem Approach: Investing In Related Companies
What do you do if you’re a cleantech startup that requires large amounts of capital? You might look for a VC with a portfolio of related cleantech companies. Some VCs are building a portfolio of related companies and encouraging cooperating among the companies, instead of betting on one or two dominant winners in a given market. The strategy is to grow an interdependent ecosystem of companies whose innovations benefit and complement other companies. Under this approach, a VC becomes a deep specialist of sorts.
Go International
A growing number of VCs are investing in companies outside of the United States. At an SDForum panel that I recently attended, a venture fund attorney noted that in most of the funding deals he has worked on recently, the money came from U.S. VCs, while the team and the markets were in other countries. In one case, the management team was in Taiwan and the R&D operations were in Israel.
The biggest challenges facing venture firms with offices and investments in multiple countries are:
- having sufficient local knowledge to make smart investments
- coordinating and communicating across borders
- physical and technical infrastructure issues
- navigating differences in exit opportunities, and
- keeping the general partners in the geographically dispersed offices economically happy, while maintaining the firm’s brand.
I will discuss these issues in future posts.
Getting Back To The Basics
In the end, VCs may not need to develop radical new investment strategies. While the industry has fallen on hard times, the key is for VCs to focus on fostering technological innovation and building companies with solid business models. That’s where the best VCs shine.
Douglas Y. Park
Twitter: @DougYPark
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