by Alan Vaksman of Digital Horizon
A couple of weeks ago, I wrote a post that said that our mighty tech-investing VC industry is not using any tech itself.
Venture stuck in the 80s, using MS Office as its main tool. While the public comments on the post were progressive, backlash from the community came in private conversations.
Non-public dialogues made it clear to me that there are a lot of problems in the venture industry that investors on all levels would like to keep under wraps.
There are a few strategic shifts:
- The difference between large multi-asset investment managers and “mega VCs” are disappearing. Traditional investment managers come into the growth stages, while larger VCs are going into public markets, PE space, venture debt etc.
- Early stage, micro “spray and pray” and highly intensive “coaching models” both have their strong following but are challenged by the amount of data available and new ways of structuring it. While not ideal, the amount of data, ML algorithms and AI help and analysis will make it an absolutely key aspect in effective and systemic sourcing and selection of startups.
- Growth stage “mega VC funds” and LPs are realizing that they don’t really manage anything in multi-billion unicorns. Hence the traditional model of charging 2% annually for management for 10-12 years, will certainly come into question.
- Current fund setups are not only expensive to administer, but more importantly make it difficult to have real valuation transparency or make use of secondary liquidity. This is about to change with secondary platforms being the key piece of the puzzle.
The VC industry is now a mature asset class. To put this into perspective, venture is a $2.1 trillion dollar industry with about 17,000 VC funds taking $45bn of annual recurring fees, and $80bn paid annually in success fees. It is also the only asset class consistently outperforming other private assets categories with over 20% average annualized return.
While not a comfortable truth, venture also takes one of the highest overall fees in private markets, with only 5% of funds realising the targeted 3x returns. The venture needs to evolve.
The industry needs to provide more consistency and rigor in the investment process which should be different for different stages. This will bring more clarity on what value the VC team adds at each stage of the investment and how the fees should be structured.
Early stage demands a lot of hands-on management, while growth stage minority interests in multi-billion companies requires much less time of a VCs. SaaS subscription models to interconnected private assets platforms may be the way to approach the later stage of venture, where objectively funds with minority shares do not manage the unicorns.
VCs need to evolve in the way we make decisions. The sector is driven by following the big brands and the FOMO, while comparatively little systemic approaches and data are used for analysis by all parties. It leads up to very limited price and terms transparency across the stages of venture.
This makes it hard to develop a market of secondaries, and all of this results in the liquidity in venture still being very “slow and low” for all the parties.
The changes will create new business models which should at the end benefit the main stakeholders of the venture funds: startups and the limited partners. However, the speed and the extent of these benefits will really depend on the reluctance of the industry as a whole.