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2021 was one crazy year for the venture capital industry. From a global perspective, it was the biggest year ever for IPOs, with 399 offerings amounting to a collective raise of $142.5 billion.
It seems that there is only too much capital. Despite rates rising, liquidity keeps flowing in private markets. Money is no object. But what is then? Founders now have the luxury to be picky about who sits on their cap table. Do they always go for the largest, most popular funds? Well, not necessarily.
Leaving artificial timelines behind
Sequoia Capital was one of the first large private equity companies to switch its strategy. Indeed, they decided to abandon the traditional fund structure with its artificial timeline for LP capital. There will only be a single permanent structure called the Sequoia Fund which will be an open-ended liquid portfolio made of public positions of their companies.
This comes in as a clash with the traditional 10-year funds, which put buy and selling pressure on the fund manager. The capital had to be deployed in the first year, resulting in non-optimal acquisition just for the sake of capital deployment. In the same logic, when the fund reached its time limit, many exits were performed way too early, resulting in important profit opportunity losses.
This new way of operating gives the opportunity to treat every opportunity in an optimal manner, buying when convenient and liquidating holdings only when the investment will have fully matured.
Bring value, not money
Of course, one of the primary elements you’re looking for as a founder when contacting Venture Capital firms is funding. It is money that will help you hire new talents, ramp up marketing efforts, and enhance your operations. But although some CEOs might be perfectly content with signing a check and it being the full extent of the relationship they have with their VC; it will not be the case for many.
In a market where VCs compete to get deals, investors will start to have to get really clear about their value-add to a potential portfolio company. It won’t be about money only, but about bringing in different skills, visions, perspectives, and networks. More than checks, VCs will have to show that they have the insights and empathy to help get founders ahead.
We also see the rise of what can be called “Specialist Players”. These actors will be committed to either a specific sector or to a specific stage (seed, first round, later series). These will focus their investments 80% in these areas, which is already what Lian Group is doing with a focus on later-stage blockchain and cloud computing companies. Having such a directed focus lets VC companies bring the best expertise and connections to their portfolio companies.
Finally, the highly uncertain market is making many investors rather risk averse. This will also create an opportunity for specialized investors that understand a niche to jump in on more ambitious ideas.
The growing importance of smaller players
What we could also observe last year is the emergence of a record of micro-funds (under $50 million, that is) that closed last year. Pitchbook shows that in 2021, 240 new micro-funds had already been raised by the time they published their US VC Valuation for the third quarter. These are smaller players, but also bring a diversity we’ve hardly witnessed before.
This induces that the success factors for smaller VCs will also be determined by the market and niche they choose to focus on. As mentioned above, being very precise and targeted about the type of business a VC wants to help might even put it ahead – or maybe by the side of – larger, traditional VCs which tend to throw out bigger checks. Specialized, smaller funds might make business much harder for generalists and mid to large-sized funds.
Smaller players coming from more diverse backgrounds are bringing exactly what companies need to establish their business. And it is not money, as previously mentioned, which often boosts valuations to sky-high levels, leaving real business value aside. What founders need are fresh perspectives, skills, and experiences. And smaller players will likely offer them just that.
Start-ups don’t want more mindless cash. They want to find the right investors to get quality advice and promising business opportunities. And Venture Capital firms will have to give them that if they want to stay competitive and relevant in the coming years, especially if there is a lot of circulating cash and a growing specialization.
Founders are completely rethinking their cap table and becoming more intentional about how they want to organize the ownership of their company. Pumping high sums is not the answer, as we’ve seen with many fintechs which recently lost 60% to 90% of their monetary value. Forget the big names: the real value might be found in the investors that stick around from start to finish and know about the reality of the entrepreneurial life.
A game of money is turning into a game of value. Strong business advice is replacing big checks. The entrepreneurial ecosystem is changing, and good VCs will have to adapt if they want to keep helping the innovators of tomorrow.