Towards the end of one year and as we prepare for the next, it seems like a good time to take stock of where this industry is going. Venture has been on a wild ride these past couple of years, with the initial hesitation in Q2 2020 brought on by the pandemic quickly becoming the catalyst for some of the industry’s most exciting quarters ever.
I won’t focus on the changes in how VCs operate, as that has been covered elsewhere. For example: The move to virtual meetings and writing a check without ever meeting the founding team in person are definitely a significant shift. Whether these remain acceptable post-pandemic, only time will tell. But unlocking global investment opportunities is definitely an exciting trend as investors learned that there are great teams to be backed in places other than a firm’s backyard. A trend that was just beginning pre-COVID19.
The current talk in the VC industry seems to be regarding a split between three investment strategies.
The first group are super-angels/accelerators/crowdfunding-platforms that continue their spray-and-pray approach to investing. Writing relatively small checks across many opportunities. Some may then double down in later rounds, but only on the perceived winners. I assume that promise is the strategy behind SoftBank’s Vision Fund investment in OurCrowd, a Jerusalem based crowdfunding platform.
The second group are the traditional VCs. These large funds are investing capital at a ridiculous pace, based on a strategy I could only define as “there is more capital out there, so let’s do this round and then quickly go get more”. These quick and large rounds inflate valuations making the VCs look good on paper so that they too can raise more capital before the markets cool off.
Let’s take a closer look here: As the larger players from PE and banking move downstream to play in the late-stage venture sandbox, these larger VC funds are forced to move in one of two directions. The first option is to innovate and create new opportunities for their investment thesis. These are firms like A16Z and Sequoia who are creating new methods for investing or finding their way into the public markets (which Ibex, formerly Lazarus, had been doing for years as a hybrid fund for private and public equities). Alternatively, they can move into the earlier stages of VC, bringing with them massive check sizes and out-of-proportion early-stage rounds of funding. This latter move can have dire consequences for founders.
You have heard my criticism of the approach to unicorn-building practiced by some VCs, pushing capital into companies at valuations that are unjustified with a hope that the value will be backfilled after the round. These do not always work out (WeWork anyone?) and ignore the fundamentals of building a business. This now seems to be happening in overdrive. To me this means that such investment decisions cannot be backed by real diligence or risk analysis. As Gil Dibner of Angular Ventures cynically asked in a recent blog post on this topic: for a large fund that believes there is more capital right around the corner – “why shouldn’t they just invest in everything?”
The third type of investor are pre-seed/seed stage funds like ourselves who seem to be avoiding the temptation of joining this free-for-all approach to venture capital. The best founders are also probably (hopefully?) avoiding the hype, taking only the capital they can actually use to build the best company that they can and from the best partners with which to do so. Eric Paley of Founder Collective covered this is in an important article on TechCrunch back in 2018 and it seems even more relevant today.
Remember, if 9 out of 10 startups fail (in Israel it is actually more like 1 out of 20 which succeed) then it is only a fraction of those successes which become unicorns. Of those who become unicorns, most will take a decade to do so!
We cannot try to compete with a brand name $B fund who decides to write checks from $100k to $50M, active everywhere from Seed to Series C. As early stage VC investors we need to write smarter checks. We need to refocus on the needs of the founders from their early stage investors. Before investing, we must take the time to create conviction in the team, their tech and the market opportunity so that we can truly be of value on their journey.
This is a strong investment thesis that requires us to filter out the noise from all the hype and resist FOMO. We are driven by a belief that this is still where the greatest returns can be created for venture investors, as a multiple of cash-on-cash return. At SapirVP we are doubling down on the strategy of investing in 50X opportunities. These are the long-term horizon, and at times contrarian, opportunities that can change the world. Change takes time so the capital needs to be patient.
To be sure, our strategy also carries new risks in this changing market. This abundance of capital could lead to some of our companies getting acquired earlier than expected, as larger rounds enable players to consolidate within their market (especially if they need to backfill value: revenue, product or talent). It will require a delicate balance between timing and exit size in order to realize the multiples of return that we are seeking.
That is another reason why being aligned with the founders is the strongest position to be in. A core part of our investment strategy. As every VC always says: It is all about the people.