By Micah Rosenbloom, Managing Partner
“Woe is me,” should not be in any VC’s lexicon. It’s a privileged job. Every day we get to meet with entrepreneurs who are looking to change the world.
At the same time, I’ve felt a shift in the mood of VCs across the Valley from elation to resignation. It feels as though venture capital is in a bit of a midlife crisis. Blue Bottle Coffee chats bemoan climbing valuations and diminishing returns, except for the 24 hours following a billion-dollar exit when the smiles return, temporarily.
The principles of venture capital have remained unchanged for decades. It used to be that you’d raise a fund, invest it over three years, hopefully, pick some winners, rinse and repeat. Now, some of the seemingly immutable laws of VC now being questioned by collaborators and friends. The vast changes in the tech ecosystem are unnerving to most everyone in the industry, especially those that live and work in Silicon Valley. These are the questions I hear most often:
Is Silicon Valley the only place to be?
High costs — for everything. Saturated market. 500+ funds. Start-ups working virtually. All those factors, plus the potential 17% carried interest surtax pending in the CA legislature might lead more VCs to ask whether it’s time to go to Austin or Seattle. “It doesn’t really rain that much, right?” they ask.
Can I make money in carry?
Most VCs never see carry but as in any competitive industry, people enter the field thinking that they’re the exception. Like Chicago Cubs fans during the drought of 1908 to 2016, many assume next year will be their year. While there will be the overperforming exceptions, most VCs, no matter how talented, may have to wait a decade or more before seeing carry, if ever. Longtime VCs may start to rethink their career choice. The household financial spreadsheets of Atherton and Pac Heights residents never contemplated an assumption of zero carry!
Are we too small?
To some, the venture business has turned into Goliath vs. Goliath. There’s an arms race for value-add talent: Heads of platform, content, recruiting, BD, etc. Many wonder, “Is the fund that I am at too small?” When Chevy introduced the super-sized Tahoe in the 1990s it quickly became the subject of parody, all while SUVs went on to dominate auto sales for the next two decades. Similarly, many initially scoffed at Softbank’s $100B fund, but now it seems normal, almost practical and wise. How can an ordinary single billion-dollar fund possibly compete? Never mind a mere multi-hundred-million dollar firm?
Do valuations matter?
VCs are quickly learn the importance of valuation, e.g. a $5M pre in a seed round means twice the return of $10M pre, and so on. But even that basic logic is being questioned. Peter Fenton in his interview on the Twenty Minute VC said, “I’ve never seen, ever seen, a venture investment from an early stage standpoint become bad because of valuation, and the flipside, I’ve never seen one become great because of valuations. It’s an amazing mental trap in that regard.”
And this is absolutely true for a firm like Benchmark that measures success by being involved with the 5–10 most important companies that are started each decade. Unfortunately, this belief that VC is simply a “power law” game has led many firms that lack Benchmark’s pedigree, playbook and track record to treat most investments like lottery tickets where the outcome is binary and the price of the ticket doesn’t matter. Of course, it does, in aggregates even if it doesn’t feel that way in this market.
Money is the ultimate commodity, how do I distinguish myself?
Should I focus on a particular vertical, like VR? Do I invent a new stage like “Mez-Seed?” Does a brand studio/fund model work? Increasingly, generalist funds are starting to question whether they should focus, while domain-focused firms start appreciating the value in a generalist approach when their formerly hot category takes a hit (e.g. many crypto funds in the last month). Big funds are starting seed funds. Seed funds are raising growth funds. It’s all very confusing and making the right call can mean the difference in becoming the seminal investor in their field or managing a basket of troubled assets, like so many clean-tech fund managers in the 2000s.
My take on these existential questions
You can make money in more places than you think. Over the last decade, Boston has enjoyed a baker’s dozen billion-dollar tech IPOs. Canada’s VCs have been characteristically modest about their successes, but they have not gone unnoticed by elite VCs. There are half a dozen tech unicorns in Utah! Utah! Sydney, Australia, has three, including one of the top 10 tech IPOs of the last decade. Seattle, LA, and NYC continue to produce extraordinary outcomes with great regularity while Stockholm and Chicago can’t be discounted either. Northern California is tech’s undisputed center of gravity and it offers benefits no other geography can, but it’s far from the only place to be successful.
It’s easier to make money on carry if you make less on fees. We’ve managed to get into carry on our first fund and are close on our second. It helps that they are $50M and $75M entities, respectively. We believe there’s beauty in being small and that just as we preach to our companies, more capital isn’t necessarily better. It’s tempting to justify raising a larger fund by suggesting that it will outperform, but in my experience, there’s often a trade-off between fee income and carry.
Valuations matter. We counsel our startups not to throw away $100M exit opportunities. We live by the same advice and can return meaningful chunks of our fund with fairly-valued companies that are conservative with capital deployment and sell for sums that wouldn’t merit a mention in TechCrunch. It’s nice when something like Uber or Trade Desk works out in our favor, but our fund strategy isn’t predicated on once in a generation outliers to be successful.
March to your own drummer. Fred Wilson just wrote that successful firms march to the beat of their own drum and he’s right. Sequoia is huge and Lowercase was tiny, but both are extraordinary examples of success. USV and Foundry have driven historical returns by staying true to themes while General Catalyst has a legendary reputation and a heterodox portfolio. When I see my peers stressed, it’s usually because they’re trying to use someone else’s playbook instead of defining their own and sticking to it.
Fear not, fellow investors. The teachings of Carlotta Perez, as popularized by Fred, clearly demonstrate there is a natural cycle to the ebbs and flows of technology and the financial markets dating back to the Industrial Revolution. More recently, I remember thinking all was lost after my dot-com era startup failed and $25M+ in venture money disappeared with it. From the ashes of that cohort came a stronger wave of startups and VCs, and a boom that has lasted much longer than the last. Long may these interesting times continue!