How to disrupt the Venture Capital industry

There are 3 main things VC’s claims to provide – money, connections and strategic advice. For the last 3-4 decades that’s worked fairly well for them since they have made good money from the management fees even if their returns have not been spectacular.

If a VC firm rises a $50 Million fund, and has a management fee of 2% per year, with 2 partners, 2 associates and a swanky office, they still get to take over $250K per year in salary and upside on exits.

The work was primarily evaluating companies and entrepreneurs, providing strategic board advice, governance to existing companies and networking.

That model assumed investments in about 10-15 companies and among the 2 partners, (7 board meetings per person), so time was tight, the only advice that could be provided was “strategic” in nature, or “connections” to folks.

There were a few top tier VC’s who would help recruit key employees or help in closing key deals, but those were rare.

What if however VC’s were entrepreneurial in nature?

What if they needed to provide marketing advice, help in structuring sales compensation and help determine product direction besides other “strategic” input?

That’s what Andreessen Horowitz is doing right now. They created a executive briefing center, staffed it with a seasoned pro (disclosure: Mark Cranney is a good friend, and others in A16Z were colleagues as well) in sales who is helping drive sales opportunities, hire sales professionals and helping entrepreneurs develop sales compensation models.

This is what YCombinator is doing as well, with their hiring of key technology folks not just the traditional “VC” material.

They can do this because their fund size is large and the founders have already made a lot of money, is the common criticism I hear from valley VC’s.

If other VC’s dont do this however, they are going to be disrupted.

VC’s everywhere have to go beyond their comfort zone, hire more professionals in technology (how about a CTO who can help invested companies with technology hiring, scaling etc.) marketing (strategic content marketing plan, etc.), sales (hiring, sales compensation, building and scaling a sales team) and operations.

What would that mean?

Lot more involvement with portfolio companies, multiple touch points besides the CEO alone and closer involvement with the companies. They’d still be busy: as much or more than they were before. This would also mean they would have to get a mile deep and few inches wide as opposed to a a inch deep and a mile wide.

VC’s would make less money in their annual salary, since the management fees would remain the same, but more people would be involved in the firm, which lowers the amount of money per person. Their chances of success with their portfolio companies should improve, which means they would make the same money as they did before, but with more of it coming from carry (the right incentive anyway).

They would possibly have to invest in fewer companies, since they just wont have the time to spread themselves thin. The problem is that VC’s  still think 1 in 10 companies is a hit, 2 return money and 7 go bust. I think to improve those odds, they will have to focus more on picking those that have some early traction, and are going after a proven market. All other VC criteria remain the same.

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13 thoughts on “How to disrupt the Venture Capital industry”

  1. I think that VC’s are becoming more like incubators and we know that incubators often provide capital investment. This is known. I wonder if in the future we will see one-stop shops for entrepreneurs.

  2. I have always thought, what if “VC”s (loose term in this senario) started 10 businesses *of their own” in a year. No poking the founders for pivots, no founders. They employed and paid smart people to further their business ideas instead of armchair quarterbacking. Am I being a jerk? If i am I am sorry.

    1. That’s more like an incubator, but VC’s could do that. The challenge is that no one has the lock on great ideas. VC’s model is based on funding extremely smart, motivated people who will not “work” for a VC, but will want to control their own destiny. This model you propose Clay has been executed before by Bill Gross of ideaLabs, but its rare.

      1. All the Germans are doing this. Check out Rocket Internet, Team Europe or i5invest. Pretty much the same model. works well for some, not for most.

  3. absolutely. although, one could also execute the “smaller pay / more people” strategy with a large portfolio as well. too many folks think that VC time is the critical finite asset, whereas it’s extremely likely that many other variables could be just as important, and are much more scalable. on fact, one could even suggest economies of scale / network effects make larger portfolios more likely to breed success. in any case, smaller salaries (and lots more hard work than the average VC) could become significant strategic advantage for innovative VCs.

  4. 100% speaks to my heart!

    Check out http://www.speedinvest.com, a small European fund that we launched last year with exactly that model in mind. We are actually five (!) partners in the fund, each earning the bare minimum to survive. On the other hand, we get a substantially higher carry, with no hurdle etc. If we do our job right, each of us will earn plenty of money.

    What do 5 partners (and two full time associates) do with a 10M fund? …Get their hands dirty in operational stuff. Basically 1.5 FTE of us do normal “fund stuff”, the rest of the team takes on operational tasks with our portfolio companies, just as you described, mainly towards the marketing / BizDev side (our angle is that we try to bring top EU startups to the US market).

    This work brings us additional equity (founders basically “pay” for having these entrepreneurial resources on board with a few extra equity points) that benefit both us as managers and our fund investors.

    To be honest, we came up with that model more or less by ourselves, simply because it was abundantly clear that the typical VC model would not work for us. One year into operations, we are more convinced than ever that our – and your – hypothesis will prove true, lets hope that our returns will validate this also.

      1. This also resonates with me. I hail from I/O ventures http://www.ventures.io where our model has some interesting points:
        – Most of the “associates” behave like EIRs so when startups come into the incubator they are met and advised by folks who have often lived in their shoes. Not number crunching MBAs who can’t address the early stage (it was a painful but well worth it transition for me- and got me “scrappy” in a year.)
        – Having a non institutional LP base also means you can leverage upstream acrionanle advice and value from aligned follow on investors. Or further the “mentor” model of experts.
        – Room to actually innovate and explore where Traditional VCs have not. I/O ventures spawned 2 new funds. Savannah Fund addressing Sub Saharan Africa and Golden Gate Ventures in south East Asia- both with backing from Dave McClure actually at 500S :)… Traditional VCs can’t do this under their current structures.

        Regional market intelligent becomes an increasing advantage for VCs to leverage ontop of the technical mentioned. Especially given that new companies are going global from day 1 and one can’t ignore emerging markets for too long.

  5. Agreed. The rise of angels, super-angels and operational savvy VCs have indeed been on the collision course with the traditional early stage VC who rely on old world parameters such as what you describe already, to position themselves in deals. There are more first-time entrepreneurs today than there has ever been and this means, they not only need the money but someone to bless them operationally on a consistent basis instead of relying on monthly board room meetings as it was in the past. Hence also the rise of operationally focused early stage investors who are fulfilling this gap. A true example of perfectly competitive market. So I agree that these VCs need to figure out how to scale their organization structure accordingly (Andreesen-Horowitz have talked about this topic in the past).

    But I think we need VCs now more than ever as well. With decreasing startup costs, we are seeing more number of early stage opportunities and many of these startups will need additional capital in series-B, C & D stages and a $50M fund cannot fulfill these requirements.

  6. This makes so much sense for VC fraternity in India as well as the start-ups here. Start ups grapple with issues around operations, hiring and others on day to day basis – they are destined to do that but I firmly believe with start up ecosystem not as evolved as some places elsewhere, participation and engagement with VC firms beyond money is of paramount importance.
    In markets where start ups is a relatively new phenomenon, the presumed success metric of 1 in 10 can be turned on its head and we can have a lot more successful ones emerging in the near future

  7. Mukund, Exactly the hypothesis on which Ojas got created and we are in to to generate returns in the long term. We have a $35m fund with four partners, very top heavy in the Indian context when you compare to most of our peers. In this nascent ecosystem, VCs need to think like business builders not financial engineers. Of course, we get our hands dirty and operationally involved be it hiring, sales, BD or structuring partnerships.

    Gautam

  8. Mukund Mohan – “The problem is that VC’s still think 1 in 10 companies is a hit” – this number should definitely change with right selection of companies to fund and if VC’s are Entrepreneurial in nature it should help.

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