March 22, 2022
Increased specialization, a re-emphasis on founder/investor fit and more diversity across the board are in the cards, members of Protocol's Braintrust say.
Good afternoon! In many Braintrust editions, we ask venture capitalists to tell us how the fields they invest in could change over time. But for today's roundtable, we asked a group of VCs to turn the lens around and let us in on what they think might change about their own roles as well as the investing landscape at large in the coming years. Questions or comments? Send us a note at email@example.com
Partner at Menlo Ventures
Venture capital is going to change seismically in the next three years. The venture capital landscape is going to be dominated by three kinds of players: We will use a naval analogy to characterize the landscape.
- Scale players, i.e., Aircraft Carriers: These would be large, multistage, multisector firms managing assets over $10 billion and investing across multiple geographies. Examples: a16z, Accel, Sequoia, Insight. I expect at the end state there will be 15 to 20 firms in this category.
- Specialist players, i.e., Submarines: These would be firms that focus on a particular area or stage. They commit to being the domain experts in one sector/stage and focus 80% of their investments in that area (e.g., Ribbit, Emergence, First Round, Unusual, etc).
- Role players, i.e., Destroyers: These would be firms like corporate venture arms (e.g., Salesforce) or crossover funds (e.g., Tiger Altimeter, Alkeon, etc.) that roam around multiple areas and plug in gaps opportunistically. They are not necessarily committed to the private markets, but will wander in and out depending on the macro environment.
Everyone currently in venture capital has to figure out which one of these three categories they fit in and build the expertise to match it. Anyone who doesn’t have this clarity or focus will eventually go out of business.
General partner at CapitalG, Alphabet's independent growth fund
Venture capital has changed dramatically in recent years. The number of firms at every stage has proliferated, fund sizes have swollen and asset classes have converged, as VC, private equity and hedge fund investors have increasingly targeted the same deals. In turn, valuations have risen, and funding cycles have condensed.
Now the markets are jittery, interest rates are rising, and there’s war in Europe. Looking ahead, I anticipate a few trends will emerge.
First, more specialization. Fewer firms will invest in all kinds of companies across sectors and stages. More will prioritize learning sectors well and developing thoughtful investment theses, both to improve the caliber of their investments and to improve the quality of their insights for partners.
Second, a re-emphasis on founder/investor fit. Today, funding rounds are often too fast for proper diligence on factors relating to fit. With the return to in-person meetings and a deceleration in the pace of rounds, both investors and founders will have more time to carefully consider who they want to partner with for years to come.
Third, spooked by market uncertainties, some newer investors will become risk averse and shy away from ambitious ideas. This creates an opportunity for more established investors who know that many of the best companies are built during periods of slowed growth.
Fourth, a flight to quality of investors with proven value-add and time to offer. Fewer founders will opt for higher valuations from hands-off investors with dozens of portfolio companies each; instead more will seek focused investors who aren’t only banking on their success but will also help them achieve it.
Partner at Lux Capital
I hope it will continue to be more diverse in every sense of the word. Funds will continue to experiment with stage and sector foci, solo capitalists will grow their teams and start to look more like traditional VC firms as they expand their portfolio strategies and it will be as competitive as ever. Three years is not a long time — and yet can be an eternity — in this industry, which moves fast and slow.
Partner at Speedinvest
I love all this hullabaloo around Web3. It might make VC look completely different. It might enable a new kind of VC fund, a new set of investors that will come together to fund a common cause, a common mission. It will enable the rules of VC to be rewritten and carry flows to be more equally distributed to all those involved in the investment process. It will fund new innovations and underrepresented categories that don’t typically fall under a VC fund’s return profile.
Partner at Scale Venture Partners
Over the last 18 months, two massive shifts have transpired; both will shape the entire venture ecosystem over the next three to five years.
- Digital transformations took place at breakneck speed, accelerated by several years due to the pandemic. Sectors that had previously been untouched by the first generation of SaaS were thrust into the cloud practically overnight by a suddenly remote workforce.
- Unprecedented capital flowed into the venture and startup ecosystems, pushing both levels of innovation and valuations sky high.
It’s important to think about these two shifts in context. While it’s likely that many startup valuations will receive a haircut in the coming months and years — and some new venture firms may even find themselves unable to raise more money for new funds — the fact remains that the total addressable markets for software are now both broader and deeper. I anticipate another technology boom as specialized, AI-powered solutions, or “Cognitive Applications,” gain traction in new markets.
What this means for venture is that the competition among firms will continue to intensify. Just as new software will increasingly specialize in order to provide additional value to new markets and ecosystems, VCs will likely also have to specialize, too. It will no longer be possible to succeed as a generic venture firm addressing all tech markets. VCs that focus tightly on specific stages and on providing meaningful value-added services like proprietary data, specialized advisor networks or even custom tools will take the lead.
Managing partner at Revolution Ventures
As interest rates rise and the effects of 2020 and 2021 exuberance cool, "hot money" seeking returns in the VC asset class will migrate away from VC to other "newly hot" asset classes. We'll see tourist investors depart while traditional institutional investors maintain their allocations to VC but focus those allocations toward (1) large platforms that allow institutions to deploy sizable investment sums at scale and (2) specialized VCs with a unique ability to elicit outsized returns — through deep industry specialization or a hands-on ability to drive incremental value. Undifferentiated VCs will have difficulty raising additional funds, either decreasing their fund sizes or exiting the business entirely.
As capital exits, the market will rationalize. Lower-quality ideas and less experienced entrepreneurs will find it harder to raise capital, while great ideas and great entrepreneurs will have ample access to funding, albeit often at more reasonable valuations. And from within this rationalization, the next generation of great companies will be born.
As the lifespan of VC funds averages over 10 years, this evolution will be slow. But the net effect will be similar to what we witnessed after the dot-com bubble, with transient money exiting the VC asset class only to rush back in upon seeing the bounty of the great companies that will indeed be minted in the coming decade. And the cycle will repeat again.
See who's who in the Protocol Braintrust and browse every previous edition by category here (Updated March 22, 2022).
Kevin McAllister ( @k__mcallister) is a Research Editor at Protocol, leading the development of Braintrust. Prior to joining the team, he was a rankings data reporter at The Wall Street Journal, where he oversaw structured data projects for the Journal's strategy team.
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