How VCs won by throwing away their rulebooks in 2021
MArk Goldberg knows how much the venture capital market has changed in recent years. A partner of Index Ventures, Goldberg remembers when investors gathered on Monday mornings to sip cappuccinos, dig into pitch decks and delve into due diligence. But in today’s record market, things look a little different. In his company, long investor meetings have been replaced with blocked time slots in case a partner needs to quickly sign a last-minute conditions sheet. “The whole way we organized ourselves has changed to fit the market,” Goldberg says. “Now the capital is on demand. You can take a round in 24 hours from a traditional venture capital fund and a host of new entrants.
The due diligence process for a potential start-up investment is extensive and involves collecting market data, researching financial data documents, and knowing a company’s founders and clients through interviews. This exercise took months on average, but in today’s market venture capitalists have a week or two to go through the process, if they’re lucky. Most have to cram months of diligence into a weekend or, in some cases, a single day. VCs have adapted streamlined strategies based on efficiency, while trying to avoid sacrificing quality.
For many, this has meant making the process more fluid than formal. VCs don’t wait for companies to come talk to them, instead, they are constantly tracking and collecting information about startups that could be potential holding companies in the future. Multi-story company Felicis Ventures even hired a research manager in 2021 to help them with this task. Highlighting work gives VCs a “prepared mind” – as several investors say – allowing them to act quickly when presented with a condition sheet. “We have done months and months of invisible work for the founder,” says Goldberg. “The diligence is more intense now. It’s just that you have to pick your battles and be ready with a minute’s notice to say yes. You have to make a decision three months in advance.
Seed-focused micro-fund Bowery Capital says their small team managed to scale the process in two to three weeks, but can do everything they can to get things done faster if needed. Bowery general partner Mike Brown says Forbes That operating on an accelerated schedule has prompted the company to place more weight on new areas of due diligence. “We are really over-indexing the team and clarifying their past execution ability,” said Bowery, noting that as a seed investor, these decisions surround a potential relationship of more than 10 years. “If there’s one thing we can’t go wrong about, it’s picking the wrong founders. “
As a solo general partner, Nisha Desai, founder and managing partner of Andav Capital, said the last year had forced her to be incredibly disciplined with her time to make sure she gave herself enough time. to research and prepare properly. Fortunately, she thinks the founders looked into the dynamics as well. “I will say the founders got smarter when it comes to due diligence. I rarely go in depth or even make a first call, until I have enough information, ”she says. “This is something the founders should recognize for solo GPs, our greatest asset and our most valuable asset is our time. We are only going to spend time with you if we think there is something.
With the squeeze on due diligence comes a huge new influx of capital into the venture capital world. At the seed level, the number of companies has grown from around 120 in 2013, when Pejman Nozad started his Pear business, to “in the thousands” today, he says. Solo stores like Desai’s Andav Capital are also gaining momentum. In some cases, angel investors have “turned into a more institutionalized business,” says Defy Partners founder Neil Sequeria. The abundance of capital has, in turn, enabled companies to raise funds at an unprecedented rate, says Jules Maltz, general partner of IVP. Hopin, a virtual events startup in which Maltz’s company has invested, has raised four rounds of funding since June 2020, bringing its valuation to $ 7.8 billion from $ 245 million. “Historically, 18 months was a good time between one round and the next,” says Maltz.
Although the most active investors in 2020 were blue chip venture capital firms, the first half of 2021 saw cross-funds Tiger Global and Insight Partners take the pole position, according to data from Crunchbase. “Hedge funds and public investors who have entered private markets have pushed existing private investors like us to start improving our game on how we do due diligence,” Maltz said.
But while venture capital stores have been forced to adapt in some ways to the hedge fund manual, they are also changing the industry on their own terms. “One thing that I think Andreessen Horowitz started that isn’t often attributed to them is this investment strategy where you put huge sums of money into a seed deal that has nothing substantial to validate yet. evaluation, ”says Yanev Suissa, Managing Partner of SineWave Ventures, a company specializing in supporting startups in the public sector. The logic of these heavyweights, with whom SineWave often co-invests, is that a huge portfolio success is enough to validate all high risk bets.
“I think the other big traditional venture capital funds will be forced to follow this trend,” Suissa said. “They’re already starting to do it and they’re going to continue to do it even though there isn’t a ton of financial discipline associated with it. This will be a problem in the future that every venture capital fund will have to deal with. “
Forbes reported in December that data connector startup Airbyte had raised funds at a valuation of $ 1.5 billion despite its annual recurring revenue not yet reaching $ 1 million. Another example in Andreessen Horowitz’s own portfolio is data infrastructure startup Anyscale, which raised a valuation of $ 1 billion in December despite reports that its annual recurring revenue was less than $ 5 million. Co-founder Ion Stoica argues that the company’s open-source origins justified its valuation markup because it created a market before sales even began. He cites successful open source companies such as Databricks and Confluent as a precedent; Even still, the two companies were valued at half the price of Anyscale at the same stage of funding. In the case of Databricks, the company had revenue of $ 12 million before its increase. For Ben Horowitz, who has invested in both Databricks and Anyscale, the influx of unicorns is just a sign that VC is finally starting to reflect the reality of the market.
“I think people are confused by the numbers when you compare them to historical valuations,” Horowitz said. “In some ways everything was undervalued in venture capital in the sense that we were doing very cheap business for things that could be worth $ 100 billion. Prices are catching up with what is really going on in the world.