The extraordinary boom in private funding for early-stage businesses has attracted banks and mainstream investors into territory long‑dominated by venture capital firms. In response, some venture capital firms are starting to look more like banks and mainstream investors. This seems a risky strategy.
The top venture capital firms have had a spectacular few years, with returns outpacing those of even the leading private equity funds. That has sucked in more money, boosting global venture capital investment to more than $600bn last year — double the 2020 figure. Much of the growth came from non-traditional investors, such as private equity funds, family offices and pension funds.
Big public market investors such as BlackRock and Fidelity have moved into early stage investing, as have private equity firms such as Blackstone and KKR. According to Pitchbook, $78bn of deals in Europe last year involved non-traditional investors.
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Many of the big deals, which historically would have been handled solely by venture capital firms, involved banks, which have strong relationships with big investors. This puts the banks in a good position if companies then decide to go public. The pitch to them is partly that the banks can offer them a broader range of funding options than venture capital firms can.
Just as leading private equity firms have branched out from their origins in buyouts, so some big venture capital firms have been diversifying. Sequoia, one of the world’s top venture capital firms, has been leading the way. It has added a range of new funds and has also recently announced plans to change its model by creating a permanent structure that will channel money into individual funds. This change would allow assets to be held for longer and mirrors similar moves made by some of the big private equity firms.
Sebastian Mallaby, author of The Power Law: Venture Capital and the Art of Disruption, says it is “amazing” how much “franchise risk” Sequoia has been prepared to take. “They were a traditional early-stage investment shop in 2000 and then they grafted on this growth equity business. They grafted on a hedge fund business… Now… they’ve got permanent capital, so they’re going to end up with multiple business lines,” he told the Conversation with Tyler [Cowen] podcast.
Some leading industry figures agree that firms are taking a big risk by expanding. The pursuit of scale is not healthy, according to Keith Rabois, one of the early executives at PayPal and now a partner in Founders Fund, the VC firm headed by billionaire Peter Thiel.
“So the problem… like banking… is there is vertical integration. So everybody is becoming a full stack venture firm — traditional venture capital, Series A and B, into growth capital. And we are the same,” said Rabois on the New York Times’ Sway podcast.
He argues that if funds don’t offer the full suite of funding, they may get eclipsed, but they risk losing their distinctive edge, just as happened in investment banking.
“These specialised banks basically disappeared. And so everybody became a large bank, where they lost basically their market share. And so in venture, that has definitely happened.”
Becoming bigger and more complex businesses may also involve VC firms becoming more conventional businesses. This could increase the pressure on firms to conform to norms by, for example, addressing their woeful record on diversity. Some insiders worry it might also reduce their tolerance of unreasonable mavericks, which is what most very successful entrepreneurs are.
Some experts believe VC firms face a further challenge, this time caused by a shift in the nature of the investment opportunities. In recent years, a large proportion of venture capital funding has gone into information technology and e-commerce. Yet now there is more excitement about “deep technologies” in fields such as clean energy, bioscience, artificial intelligence and quantum computing.
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Ramana Nanda, professor of entrepreneurial finance at Imperial College, argues that the modern venture capital model is less well-suited to startups in these areas, which tend to require more investment over a longer period than IT or e-commerce firms do.
Mallaby rejects that argument, pointing out that further back in its history, venture capital was more about investing in hardware than software. Moreover, while some areas such as biotech have proven more difficult for venture investing, this may change, thanks to innovations such as gene sequencing, which have made it faster and cheaper to develop new drugs.
The bigger threat may be increased competition, the growing scale of leading venture firms and the sheer weight of money chasing a finite number of opportunities. It may be that the success of venture capital — or, more accurately, the success of a few firms at the top — will now result in the toughest test of the model yet.
To contact the author of this story with feedback or news, email David Wighton
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