To date, our 10-year anniversary content series has looked back at some of the historical lessons of venture capital investing during the last decade. We’ve also considered some of the most interesting or critical developments in VC that we see taking place right now, as well as recent trends and helpful observations.
While these musings are by no means exhaustive, it’s still time for us to consider “what’s next.” It’s no accident that we feature that phrase prominently on our website. The future is always on our minds. That’s true of any investor to some degree, of course. But as we have noted in our other articles, we tend to have both a forward-looking and a practical approach to working with young companies. The same could be said for our views on where VC is headed.
We know, for example, that the topic is hardly unique – which is not surprising given the transformation of the capital markets over the past few years and the surge in both funding round size as well as IPOs and other exits during that time. Journalists and other commentators have taken notice, with many offering some provocative theories about venture capital’s next stage. To cite just a few:
- Sam Lessein at The Information offered a gloomy, but much discussed, view in late 2021 of VC’s future. His thesis, still relevant now, was that venture investing as it has been known for a half century would disappear, erased by the massive flows of money from huge pools of capital into earlier stage private tech companies – a historically atypical destination for traditional institutional investors.
- TechCrunch, while nodding to Lessein’s piece, also noted that the three-year trend in early stage investing was growing less fast. As in, even though angel/seed/early stage has been growing significantly, in percentage terms, angel/seed investing in the US has dropped by 50%; early stage investing has declined by ~30%; while investments into late-stage tech had shot up by over 30% during that time.
- And a piece in Forbes previously compared venture capital to the music industry – analogizing that as “makers” (music artists, or in investing terms, entrepreneurs) got closer to their markets (music buyers; public capital), venture capitalists were in for a tough time, or at least a change, due to SPAC’s, direct listings and possible retail investor access to startup equity secondary markets.
At Telstra Ventures, we think many of the dynamics cited above are accurate. But does that mean we think the future of VC is as dim as the current commentary suggests? No. Below we offer five straightforward reasons why.
1. Competition among VCs will increase – and entrepreneurs deserve it
We’ve pointed out in other posts that founders used to pitch VCs. Now, the shoe is on the other foot. As Lessein and many others note, the venture firms are chasing startups and doing so at an increasingly frantic pace. We think that’s a good thing. A big theme in other people’s commentary about the future of venture investing is essentially that capital for early stage companies is becoming a commodity, and is going to erode VC’s place in investing. Our view is different – we think the trend is terrific.
Historically, VC was about relatively small pools of private capital taking sometimes extreme risks in investing in brand new, unproven technologies for markets that didn’t yet exist, against emerging demand.
The Information compares this history, unexpectedly, to the whaling industry in the 1800s (see above). The demand for light and power was so new and growing so fast, and the solution – whale oil – so extreme that only a few would invest in the risk and earn the rewards. Have you ever heard of New Bedford, Massachusetts? We hadn’t either – but that was the Silicon Valley of its day, for whaling.
A perpetual world where innovators have to spend huge amounts of time to seek small amounts of desperately needed capital isn’t actually a good one – except for a small number of founders and an even smaller number of VCs.
If you believe in innovation – and we do – you recognize that early stage capital becoming a commodity is a welcome change. Telstra Ventures doesn’t want our founders chasing investment. We want them building great product, marketing to customers, generating revenue and growing.
If our differentiator as a firm were simply that we were one of a select group that was willing to deploy capital? That, in our view, wouldn’t be much of a value proposition. What’s actually taking place is that entrepreneurs are demanding more than just money from the institutions in their cap tables. We think this is reasonable.
The point of investment, particularly venture investment, is to improve performance in some way – not simply to improve a capital position. That’s part of the reason the investment generally comes with oversight. It’s certainly one of the reasons firms like A16Z have created entire ecosystems for support services. So what is the trend that we believe will continue? It can be boiled down to the idea that capital is the glue that binds a VC to its portfolio company and the portfolio company seeks more than capital from its VC. VCs that can offer tangible benefits to performance have a bright future. That’s why we’re optimistic at Telstra Ventures: an inherent part of our value proposition for entrepreneurs is growing sales and revenues, beyond just writing a check.
2. Scale isn’t all that matters when it comes to VC – so despite massive capital flows, venture still has a “niche”
One reason for this optimism is that the massive acceleration of capital flows into private tech companies over the past decade doesn’t necessarily translate the same way across all segments of VC investing. Specifically, venture at scale can indeed be helpful in late stage growth investing. There, large pools of capital writing big checks to accelerate more mature (but still early stage) business models makes sense. And at that end of venture investing, we’d agree that perhaps the game has changed.
But earlier and mid-stage venture investing still has a value proposition that requires expertise as much as scaled capital.
That’s an alternative takeaway from the industry data cited above and by TechCrunch. Part of the issue is risk. Even with more money and more investors interested in the kind of returns that early stage investing promises, the fact is that as a percentage of investing, truly early stage underwriting appears to be declining.
That doesn’t contradict the idea that it’s easier for founders to access capital – since so much money is pouring in, even a smaller percentage can mean more money on a raw numbers basis. But it does mean that finding the right fit between capital, operations, a founder’s vision AND returns remains hard to do, and do well.
We’d agree with the commentators therefore who believe that the number of VC firms overall will decline – especially late stage. In contrast, we think that seed stage firms will continue to multiply, and that competition will increase there. Mid-stage, mid-tier firms like ours will probably also decrease in number, as differentiation starts to matter more in terms of what the firm can actually contribute to performance.
That is VC’s future in the next ten years. But we don’t judge opportunity by quantity. We’re believers in quality – and that means that although we’ll see drops in the number of firms calling themselves venture capitalists at the late and mid stages of VC, the ones that remain will do what they do better.
3. Markets go in cycles – money won’t always be so plentiful
One thing some commentators overlook is that the capital flows into private tech aren’t just due to the search for alpha. That pursuit is tied to interest rates and a wide variety of macroeconomic conditions as well – which leads to a rebalancing of portfolios, which leads to funding for asset classes like venture capital that are focused on massive transformations powered by ever-increasing adoption of software. This kind of step-change means that venture will be able to attract and deploy capital for decades and decades to come.
Certainly the growth in the markets overall in the past ten years has been unexpectedly resilient. But at some point, there’s always a correction. The same will be true for venture capital. We believe that early stage investment in terms of total dollars will be larger in 2031 than it is now. In those circumstances, once again, we believe that differentiated VCs with a long track record, who have survived the competition from larger and smaller institutions, will have significant chances to create value.
In terms of that survival, one other prediction is important to navigating market cycles effectively: the application of data science to venture investing. While there will always be room – especially at the early and middle stages – for instinct and experience, the other reality is that the next ten years will see VCs increasingly using data science to source investments, to evaluate their metrics vs. benchmarks better and to optimize portfolio company performance. Gathering, tracking and analyzing a key set of metrics to determine outlier directions for capital will become an essential skill set for VCs. Some, like Telstra Ventures, already do this well. Similarly, the expertise of firms like Google Ventures, Rocketship.vc, SignalFire and others in using data to decide whether or not a portfolio company is really going to outperform? That too will become critical to VCs competing for entrepreneurs.
The Information used whaling as an analogy for VC’s past. Our view is that an analogy for VC’s future is Michael Lewis’ take on the quantification of US Major League Baseball, in Moneyball. Just as in baseball, there is room for an experienced eye, intuition and relationship. There is also room for an objective assessment of statistics and related analysis – free of sentiment.
4. Software and technology-driven transformation is not slowing down – it’s just getting going
One of the assumptions underlying a lot of the dramatic commentary about VC’s future is that software innovation and entrepreneurship in particular is no longer all that risky. The argument is that we’ve had a half century or more to study and model the commercialization of code – and there’s a playbook now open to anyone. Cue the exit music for VCs willing to take on outsized risks.
Of all the predictions out there, this is the one that confuses us the most at Telstra Ventures. From where we sit, both the data (which drives us) and our experience suggest that, if anything, the “software or digitization” of everything is accelerating. Much was made a few years ago about “the Internet of things.” While that may be less talked about right now, it’s never been more true. We’re just at the beginning of devices talking to devices, and mass audiences having ever more seamless, immediate and immersive exposure to tech. The only area of widely-viewed commentary that seems to document this is analysts and journalists covering the cloud wars. It’s fairly well recognized that for all the fast growth of huge cloud businesses like those at AWS and Microsoft, the adoption of cloud systems, services and technology is still in its relative infancy.
That, in turn, means we remain just at the beginning of a massive transformation of the enterprise. In Telstra Ventures’ view, this means that there’s never been a better time to invest, and help new companies enable that transformation. A key Telstra Vetures opinion on this front: disruption of legacy tech isn’t the only way to define this opportunity. E.g., transformation isn’t always about destruction of RIM’s Blackberry business (a terrific one for the world it built itself for) by the iPhone/smartphones. It can also be about radically changing the way legacy businesses use cutting edge technologies – IF innovative new businesses can fit themselves into the demand/procurement cycle of the legacy businesses.
This point about innovation is another argument in favor of the bright future of VC investing. Innovation has not plateaued. Ten years ago, AI, edge computing, gamification, crypto and many other fields barely existed commercially and attracted few dollars. Now, they’re essential target areas for early stage capital. Ten years from now, the situation will continue to evolve at an accelerated rate. So the commoditization of the software playbook – if that’s even accurate – in no way speaks to the irrelevance of venture capital. Innovation will keep business new, and that in turn will keep venture relevant.
5. Specialists will multiply; revenue will remain a constant
This takes us to our last prediction, which cycles back through a recurring point in our post: the future of venture investing really comes down to differentiation. If, in the past, there was a period where VCs sought out opportunities others overlooked or feared, that time is over. However, the idea that there is nothing unique about capitalizing a young business; or that young businesses won’t need different kinds of help to truly succeed, as well as different types of equity investments on different terms? That’s just wrong.
The availability of capital just means that in the future, where there is a healthier balance of power between VCs and entrepreneurs, we’re going to see more specialization of venture investors. The reality is that entrepreneurs need different things, at different stages – and not just different types of capital. So a new taxonomy of VCs will emerge – not just of those who focus mostly on sectors like financial services or healthcare. Not just of the best-capitalized ones who build entire resource ecosystems like A16Z. There will also be specialization based on “stage.” Early VCs will become more product-market fit focused. Mid-stage VCs will become more go-to-market and scaling focused. Late stage will specialize in providing a bridge to IPO, M&A or secondary liquidity. (In fact, the latter is clearly already happening.)
For venture investing to be more than “spray and pray,” there’s always going to need to be that fit we cited above between capital, operations, a founder’s vision and returns. At Telstra Ventures, the path to that fit – and to differentiation – begins with data, and ends with revenue. Every startup needs it to grow. Every startup also needs that revenue to be profitable, to succeed and scale.
Some VCs focus on the tech stack. Some focus on network effects. Some will focus on many other areas like those we outlined just above. Telstra Ventures, however, focuses on actually helping our portfolio companies find, capture and grow real, recurring revenues. We’ve generated hundreds of millions in revenue for our portfolio companies, for example.
So, as we look to the future of VC, we don’t see a terminus. We see as much, if not more, opportunity than we’ve experienced over the past decade. Certainly, our industry is entering a different phase. It’s becoming more global than local; there’s far more competition; capital isn’t defined by its scarcity; and we’re likely to become more transparent and perhaps more regulated. But all of those observations are typically true about any set of markets and market participants that persist and evolve.
At Telstra Ventures, we know that this new phase, and new firms run by a new generation of more value-added, specialized and data science adept investors, will remain the same in one respect. As long as growth is valued by markets? Revenue will be relevant. So, as long as we have a unique ability to bring not just capital but also our Revenue Bearing RelationshipsTM to the table, Telstra Ventures will be able to help a broad set of extraordinary entrepreneurs.