Venture funds, traditionally, have been extremely selective about their investments. Many firms barely make 5-10 investments a year, and only about 50 investments in the entire lifetime of a seven year fund. Lately, however, I am observing a different structure emerging in the early stage market. Instead of 5-10 investments a year, some investors are making 50-100 investments a year. What’s behind this trend, and what’s in store for the future?
Of course, the pioneering practitioner of this mode of investment is Ron Conway. In a Fortune article, Ron Conway is a Silicon Valley Startup’s Best Friend, his investment model is profiled at length. Some excerpts synthesize the highlights:
Conway may not be a brand name outside of tech circles, but in the startup-fueled economy of the Bay Area, he’s a ubiquitous character with an outsize personality who is often called the godfather of Silicon Valley. It’s a moniker he’s earned, in part, by investing relatively small sums in more than 600 Internet companies since the mid-1990s. Hundreds went bust, but there are a few you might have heard of. In the first Internet boom, he bet on PayPal and Google (GOOG). In the social media frenzy that is fueling the tech world nowadays, Conway has invested in Groupon (GRPN), Twitter, Square, Dropbox, and Airbnb – and those are just the companies whose valuations top $1 billion apiece. Others, like AdMob, Mint, and Zappos, have already sold for nine-figure sums.
VCs do not necessarily ‘like’ the model, but they do not publicly criticize it. Most do business with Conway, and try to get to the winners that bubble up in his portfolio. Inevitably, some winners emerge, like Google and PayPal, as well as some others like Twitter, Zappos and such. His network is stellar. He exercises it on behalf of the entrepreneurs in his portfolio. It produces game-changing deals.
While Conway started doing this in the mid nineties, in the last decade, others have followed suit. Dave McClure with 500 Startups, YCombinator, and Google Ventures area practicing this model in Silicon Valley. While Ron Conway’s SV Angel is a barebones operation, and the real impact comes in through Conway’s network, Google Ventures has a hands-on staff of 50 that helps entrepreneurs with product positioning, UI design, and go to market strategy. Somewhere in between, 500 Startup works with a ‘mentoring network’ model, while YC runs a mini university. In each case, the networks are prized, and deployed aggressively to help companies gain leverage.
One of the most interesting trends that I see in this game is Sequoia’s move into the space with their somewhat stealth-mode Scouts program. Through their powerful network of entrepreneurs and executives, they are offering to invest $25k-$50k in a large number of startups, outsourcing the due diligence to those trusted third parties. Similarly, Ron Conway has been funding ALL YC companies (about 120 a year), outsourcing his due diligence to Paul Graham, founder of YC. Sequoia has also invested in YC’s own fund, creating a preferred relationship. And Andreessen-Horowitz has created a preferred relationship with Conway’s SV Angel with their investment in the latter.
This flurry of activity begs the question what should large venture funds do going forward to ensure that they are in the game and can, consistently, source promising fledgling investment opportunities? Is it now essential that every larger venture fund that wants to do highly selective, focused, later-stage investments, must have a partner in the early-stage game to really play the field and help them identify and build relationships with the promising ones?
There is another layer of complexity coming into the picture now. The game is becoming more international, so deal flow, due diligence infrastructure, deal screening capability – all of it needs to be spread out, with international coverage. Promising entrepreneurs are sprouting from Bangalore to Barcelona to Brazil. The Silicon-Valley focused strategies of most venture funds are facing pressure to broaden. Many have set up offices elsewhere, to focus on specific geographies like India, China, etc. But investing in hundreds of funds across hundreds of geographies simply doesn’t fit the rather small, niche, cottage-industry-style model of most venture funds.
The good news: entrepreneurship is alive and well, and has spread well beyond the Silicon Valley boundaries. It has become cheaper to start companies and get them off the ground. New trends like CrowdFunding are promising ways to plug certain seed funding gaps. And the above-mentioned trend of funds making large number of investments have been certainly disruptive and thought provoking.
So, overall, I’d say, we have made some progress in exploring alternatives to the traditional venture fund model.
Personally, I am still looking for the scalability factor in all this: How do we stimulate a million entrepreneurs with small amounts of capital, adequate mentoring support, network assistance, etc.? What is the right financial services model to address that problem? Is it a crowd funding exchange? Is it a deal screening and recommendation service that works with all the regional crowd funding exchanges, as well as other types of funding sources?
In other words, what is the scarce commodity here? Money, or a scalable due diligence system that can effectively deploy the money into deserving early-stage businesses without creating a mess reminiscent of the dot com bust or worse, the more recent mortgage fisaco?
Please share your thoughts.
Note: YC has just teamed up with four VCs who are each going to invest $20k per startup: Yuri Milner, Andreessen Horowitz, General Catalyst, and Maverick Capital.