Though this may be a tough pill for some investors, we are never going back to the days where venture capital firms can win by being the only term sheet on the table — the industry has raised too much capital for that to be possible, even for the most exceptional startups.
As VCs continue to financialize themselves as the hedge fund and private equity industries did in decades past, VC firms must win with information advantage or by building the power and founder relationship to beat competitors head-on.
Offering startups more money at higher prices was recently a popular way to secure allocations in desirable companies, but whether such decisions were backed by rigorous and compelling data was often questionable.
Regardless, there are indeed legitimate, hard-earned info asymmetries that lead to unique deal access: exceptionally intimate founder relationships, superior sourcing processes, the capability to synthesize clear-eyed theses and so on.
There are also ways to win in purely competitive scenarios where VCs have material information that their peers don’t, but I wouldn’t bet on the vast majority of firms getting much more than the marginal allocation left over by a16z, Sequoia and other large, sophisticated firms.
In any case, it seems clear that the winners in venture over the next decade will be full-stack firms that continue to financialize the industry and boutique firms that successfully leverage specific networks or knowledge bases. Looking deep to the vision and initiative of each founder is the only way forward.
So, how are firms evolving with this in mind?
Collecting deal flow: It takes a village
Sequoia innovated with their scout program years ago. In hindsight, it feels obvious that plugged-in operators tend to get the first look at founders spinning out to build a company. But at the time, this deal-flow strategy was rather unique.
These days, as most firms have either copied or considered copying the scout program structure, deal flow becomes more commoditized. We’re approaching the limit on how much firms can offer scouts in terms of carry or check sizes. There’s limited loyalty, and deal flow often finds itself quickly propagating around anyway.
The advantage is no longer in the concept of a scout program, but rather in new ways to find more deal flow than an internal team could ever source on their own.
AngelList has done a wonderful job with Rollup Vehicles (everyone can be an angel), SPVs (everyone can be a GP) and funds/subscriptions (everyone can be an LP). The data gathered by owning this infrastructure is nearly unparalleled, and enabling this functionality makes a difference to those that use it.
Firms that consistently write small LP checks in emerging managers have also done a great job of “buying” deal flow at large scale. For example, a16z systematically evaluates the investments made by angel, “micro,” and seed funds they back. What an excellent way to get a scoop on future rounds before any formal processes are run by founders!
These examples represent two extremes: Tools like AngelList “arm the masses” of the tech world, while a16z’s strategy works well for those with billions to invest.
I expect firms to be highly intentional and experimental in finding new ways to organize external sourcing networks with new incentive structures.