The Tourists Have Left: VC Industry Status/Trends and Implications for Entrepreneurs
In recent weeks I’ve had conversations with a number of entrepreneurs about the profound ongoing changes and restructuring of the VC industry. Some of these changes are visible publicly; others happen largely behind the scenes.
Silicon Valley Bank recently put out an excellent 10-page white paper analyzing the last decade of venture capital industry performance, as well as the current landscape. It has some of the best actual data I’ve seen (as opposed to a lot of hand-waving and hypotheses that get bandied about on VC blogs, much of which is inaccurate).
The white paper is linked here as a PDF file.
I think this is a must-read both for understanding the environment in which your current VC investors are operating, if you have already raised venture financing, as well as understanding the context for any future fundraising efforts you are planning.
One particular issue highlighted by the white paper is the consolidation of the VC industry. The chart presented here, excerpted from the SVB white paper, shows the number of VC firms rising from 150 firms nationwide in 1991 to 1,200 at the height of the bubble a decade later, and now falling back to about 450 today.
The reality is even worse. I have access via some proprietary analysis to data showing that the number of VC firms nationwide today that actually have the ability to invest in a new portfolio company (as opposed to make a follow-on investment in an existing portfolio company) is now less than 250.
Among those 250 firms, there is a very clear “barbell” effect: a small number of high-profile firms have raised larger funds than ever and largely are focused on providing late-stage ‘growth equity’ to companies that have already demonstrated clear exponential growth. Such firms include Sequoia, KPCB, Andreesen Horowitz, etc. Such firms are probably about 20% of the 250 total active, i.e. about 50.
Another 20% of those firms are actually corporate VC funds (either explicitly or, in some cases, implicitly, where what looks like a private VC fund is actually a single LP fund acting on behalf of a corporate parent). Unlike past economic cycles where corporate VCs tended to enter at the top and exit at the bottom, they have learned their lesson and so interestingly, the rate of corporate VC investing in both dollars and number of corporations doing investments is higher than ever today.
The other 60% of the 250 are much smaller “boutique” funds (such as Flywheel) that have specific strategies focused on sector, geography or stage. About half of these firms are completely new in the last 10 years. In general, they mostly focus on seed and Series A investments, and they are heavily concentrated on consumer Internet, mobile applications, and/or China. Geographically, they are much more concentrated in Silicon Valley than before. VC firms in geographies outside of Silicon Valley have faced a much higher death rate in the last few years than those in the Valley, so even if you are able to get new investment from firms like Flywheel that operate outside the Valley, have new capital available for new investments, and invest in sectors other than those above, you’ll still need to likely raise syndicate/co-investment financing from CA-based firms.
As a result, the stark reality is that, if you do not already have exponential growth in customers, revenue, users, or other similar metrics, the number of potential venture firms who might join your syndicate for a Series B or Series C round is limited, depending on your sector, to anywhere from a few dozen to just a handful, and they are probably in California.
What this means is that if you do not already have evidence/data of exponential growth, but need to raise Series B-C money, you need to start building relationships today with corporate/strategic VCs more than you might otherwise do so, and also spend time identifying the very small number of active VC firms who might fit your specific criteria. Beyond that, you need to invest more time in considering alternatives to VC for future financing. Finally, you need to have conversations with your existing investors at least 6-9 months before the end of your current cash runway, in order to figure out how to financing your cash needs from existing investors if possible. Recently we have seen a few examples of companies that waited until they had 1-3 months of cash left to begin those conversations, and hadn’t considered how much the external environment in which their existing VCs are operating has changed. The result has been punitive at best, even in cases where the company has created incremental additional value since the last financing, but hasn’t yet shown evidence of exponential growth in key metrics.
The good news is that the VC industry’s own “right-sizing” is probably more than halfway complete, and so things going forward look better. In addition, the odds that you are going to face VC-funded competitors are much lower than anytime in the last 20 years. As a result, more than ever, your destiny is more under your control. If you can truly deliver value to customers and users; iterate and prove a business model that yields profitable growth; and demonstrate scalability in a capital-efficient manner, the odds of winning your category are actually higher than they used to be.
Put more succinctly: the tourists have left venture capital. Those who are left are the most committed, experienced, and successful VC investors, so your odds of getting true “value add” from investors are better than ever.