Finding Genius Read online

  While these anecdotes will be used to besmirch the name of venture capitalists who are truly founder-friendly, it is important to note that entrepreneurs are not free of blame in many of these cases. Entrepreneurs paint a picture of the world to rally venture support and in the process often gloss over important details, exaggerate projections, and in some cases, fabricate stories to win venture financing. As an ecosystem, venture capital and startups are being held to a higher degree of discipline and transparency through the reporting of the media. It is important for the media, as well, to do a better job of capturing the honest realities of entrepreneurship; along with the massive financings and lofty valuations, they must also cover — and celebrate — the struggles entrepreneurs face and the partnerships they forge with venture capitalists to use technology for the betterment of society.

  CHAPTER 9

  THE FUTURE OF VENTURE CAPITAL

  “Venture capital is no longer the ‘cottage industry’ it was when it started. I think there are a lot of people in venture now that have never seen a bad cycle or a downturn. There are fund managers that have only invested during this decade-long boom. Any rational being realizes that things won’t always go up. It is easy to invest money, it’s hard to find ways to get it out.”

  Ellie Wheeler, Greycroft

  The rise of venture capital from the 1950s has been swift and fierce. From the trail-wise sidekicks who supported private investments for entrepreneurs returning from World War II to backing geniuses such as Mark Zuckerberg, Steve Jobs, Elon Musk, and Jack Dorsey, venture capital has established a place for itself in the entrepreneurial ecosystem. In its evolution since, venture capital is more transparent and more accessible than ever before. The industry, in some ways, has begun to transcend the ‘old boys club’ of a few funds wound together in a tightly-knit, impenetrable investment network. Through supporting innovation and the entrepreneurial spirit, the venture capital industry has lived up to the promise of spurring the American economy. As entrepreneurial culture continues to become the bedrock of most modern societies, the international demand for venture capital funding continues to grow.

  In 2019, venture capitalists who pride themselves on being disruptive to old and stodgy industries approach the venture industry from a critical perspective. Encouraged by greater competition, they are testing the limits of their own funds with the hope of generating higher returns for their investors and becoming more efficient stewards of venture capital. More importantly however, in 2019, the venture capital conversation is centered around equality within the ecosystem and the power these investors yield. The anecdotes and lessons shared throughout this book reveal that the venture capital model is not identical from one fund to the next. The definition of ‘entrepreneurial genius’ also varies from one investor to the next. In this discourse, entrepreneurial ideas and diversity find the room to thrive. Like entrepreneurship, there is no single ‘correct’ path to finding great investments in venture capital. Knowing this, venture capitalists are compelled to experiment and innovate or go extinct.

  During the time I was writing this book, there have been several pertinent trends and catalysts driving the venture industry forward: the commoditization of capital, the technological impact of blockchain and artificial intelligence, the removal of inherent bias from the investment decision process, the paths to liquidity, and the elevation of the geographic and demographic makeup of venture capital and its constituents. I explored some of these concepts with the venture capitalists I interviewed.

  Commoditization of Venture Capital & Genius Dilution

  As additional sources of capital — corporate venture funds (Salesforce, Microsoft, Intel, Nvidia, Google, BP, Boeing), sovereign wealth funds (Singapore, China, Abu Dhabi, Saudi Arabia), incubators and accelerators (TechStars, Y-Combinator, 500 Startups) — enter the ecosystem, the competition from one venture fund to another has led to a commoditization of the asset class. Venture capital funds that once operated with small teams and manageable funds are raising mega-funds as more LPs want to join the entrepreneurial boom. As more capital enters the ecosystem, investors compete for a smaller share of ‘genius’ founders. These genius entrepreneurs are in a position to demand more value, outside of working capital, from their investors. Simply said, entrepreneurs have more power now than ever before. They can raise capital from a host of different service providers and choose the provider with the best rate. Beth Ferreira of FirstMark Capital discusses this shift:

  “Venture capital is becoming more and more commoditized. Until you have established yourself and your fund, as a venture investor that delivers value and has built a brand, the only thing an investment fund should focus on is how they partner with companies and develop a reputation to win deals. That’s where having something different, something value-add as an investor, is important. I’m very focused on delivering demonstrable value quickly because it most importantly delivers on our promise to entrepreneurs and it demonstrates to the market, we are great partners.”

  Ferreira, in alluding to a16z, Sequoia, and Union Square Ventures, credits funds that have established themselves for investing in geniuses time and time again. Yet, in the venture capital industry, this self-fulfilling prophecy is important as the best entrepreneurs want to flock to the funds that have previously created ‘unicorns’, or billion-dollar valuation companies. In order to stand out, venture funds showcase the logos of companies that are high performers in order to attract more deal flow. Other venture funds launch their own publications, podcasts, or hire public relations firms to elevate their image and reputation. This is all done to ‘get into the right deals.’ Taylor Greene of Collaborative Fund echoes Ferreira’s sentiment, simplifying a VC’s job in this new competitive market into a few words:

  “People often forget, but truly the only thing that matters in venture capital is deal flow, deal flow, deal flow.”

  In order to find this deal flow, venture capital funds are evolving in unique ways.

  Platform Services

  Beth Ferreira began her venture career at William Morris Endeavor — a talent agency that represents the likes of Denzel Washington, Larry King, Kanye West, and Taylor Swift — when the organization decided to make equity investments, similar to venture capital, in startups that were strategic to its core business. In doing so, William Morris Endeavor’s venture arm had at its disposal celebrities who could promote consumer products or startups to their fan bases. They did exactly this with Masterclass, a popular video subscription service where experts teach an audience about their craft. Through Masterclass, Malcolm Gladwell teaches subscribers how to write, Stephen Curry shows his viewers the method behind his spectacular three-point shot, and Serena Williams teaches aspiring tennis players how to hit a powerful forehand down the line to defeat an opponent. William Morris Endeavor’s unique differentiator is access to talent, and this becomes the ‘platform service’ for the venture fund. William Morris Endeavor, Hearst, Salesforce, Google Ventures, Nvidia Ventures, Intel Capital, and JetBlue Ventures all promise some corporate-related value-add to its founders. The concept of a service offering that extends beyond capital, also known as platform services, is not restricted to corporate venture groups. Instead, this practice was pioneered by traditional VC funds, more specifically a16z.

  As of 2019, a16z has several dozen professionals working at the investment fund, but only a small percentage of those are investors in search of genius. The rest of the team supports portfolio companies with recruiting, marketing, finance and accounting, data analysis, and other operating tasks as part of the relationship. Venture funds have institutional knowledge on how best to scale a company and can infiltrate companies at every level to propagate that knowledge. Platform services are one of many ways venture investors are evolving against the backdrop of increased competition. Lindsey Gray, a partner who manages platform services for Two Sigma Ventures, explains how the data-focused fund differentiates itself to seed-stage companies that are being chased by a highl
y competitive venture industry:

  “The strategy behind platform services, as a term, is to focus and be specific on how your venture fund can be helpful. A lot of funds are now focused on ‘platform’ but the strategy falls apart when they are not focused on something unique to them or their ethos. The two things that Two Sigma has, that most venture funds do not, are related to our parent company. Our platform strategy is based on the history that Two Sigma started 15 years ago as an engineering and data science startup. The founders had to figure out how to hire the best engineers and data scientists, and then train them to be managers. How do you grow people into leaders who joined here when they were 22, but are now managing an organization of 500 people? In an engineering and data science environment we help our portfolio companies with those specific issues — product, engineering, data science, and organizational development, and the reason we do that is because we have a resource that other venture funds do not.”

  Gray expanded on the traits of genius laid out by Fred Wilson and elaborated that for some funds, platform services also means helping founders develop those areas of risk management, storytelling, recruiting, and execution. Given that all founders face the shared challenge of recruiting, venture funds have actively hired talent partners who are responsible for filling the talent gap within a high-growth company, so that the founders themselves can continue to focus on execution. In other cases, venture funds are hiring public relations firms to tell the company’s story, or they are having their own staff execute on customer acquisition or product development. In all of these cases however, according to Gray, the trick is to teach the founders to manage these areas on their own:

  “The flaw in platform services, if not executed properly, is that venture funds are not teaching the founders to fish for themselves and the founding teams become reliant. This may not have to happen in the beginning when there is a firehose of issues but by the Series A, a founder should not be reliant on their investor for figuring out what the talent or execution gaps are in their company.”

  As the pendulum swings and entrepreneurs gain more optionality on sources of capital, they are able to select the investors who can truly add value to their vision. As discussed earlier, this may also manifest itself as investors who have deeply-held theses or beliefs about certain systems that can complement a founder’s view of the world. There are anecdotes of founders walking out of venture funds that did not display enough diversity within their own teams. And in some cases, as companies become more valuable, founders can also retain control of their company even as they accept cash from investors who are desperate to join a high-flying startup. The cyclical nature of venture capital, however, implies that while the economy is doing well and venture funds are able to compete for entrepreneurial talent, in a downturn the opposite often happens; entrepreneurs can get caught in the middle of building a company and not be able to raise follow-on financing to execute on the vision on which they originally set out to achieve.

  New Modes of Investing

  As venture funds increase in size, they have two potential strategies. One is to expand their investment focus to all sectors, increase their partnership to manage this capital, and truly take bets across every sector. Another strategy funds employ is to take more small bets at the earlier stages of a founder’s journey and then continue to invest heavily if the company succeeds past the first stage. Seed funds once invested at the earliest stages of a company by making an investment solely on a vision but have now moved further up the investment stack and want more proof points prior to investing. As a result, to fill that gap, a new type of fund has emerged called “pre-seed funds,” which step in to write checks for $25,000-$100,000 as initial capital to provide the entrepreneur with the support needed to quickly test business models or ideas. This is one shift that has occurred as more capital enters the venture ecosystem.

  Simultaneously, over the past decade, technology and the Internet have opened up new fundraising avenues.

  Digital Investing and Coin Offerings

  Ironically, despite the abundance of venture capital in the ecosystem, entrepreneurs still face a series of challenges in raising venture capital. The model is inefficient, largely network-driven, and a lack of transparency exists where founders have an overwhelming knowledge gap to cover. Likewise, many venture funds are putting more capital behind the same few companies rather than giving all founders an equitable chance.

  This problem drove Naval Ravikant to build AngelList. Ravikant is an angel investor in Postmates, Uber, and Twitter. He is also the founder of Epinions, Venture Hacks, and as of 2010, AngelList. Ravikant believes that the venture industry operates by arbitraging information. The prevailing sentiment in Silicon Valley is that venture capitalists compete to find a hot deal, before the deal is competitive, and that their competitive advantage is often solely due to the networks that they are part of. Outsiders are unable to invest in promising companies and the venture investors with the most established brands and networks gain access. Ravikant is a believer that as capital becomes commoditized in the future, large, brand name venture capital funds will be inconsequential. He believes in an unbundling of large corporations and funds where people will have more independence and have their own brands, instead of being centralized around one institution.

  While angel investing and investing out of a small venture capital fund, Ravikant recognized that in an age where the flow of information was often free, venture capital deals should not be so exclusive. His vision was for a platform that distributed and monitored deal flow and also allowed ordinary individuals to invest in earlier stage companies. This marketplace solution, if executed correctly, would also make it easier for founders to quickly raise capital without having to go on a long roadshow. AngelList has evolved into an online-funding marketplace that connects investors with early-stage ventures. Collectively, as of 2019, AngelList has reportedly executed over 1,200 deals through the platform and raised hundreds of millions of dollars for early-stage founders. Still, the venture community is hesitant to acknowledge its success. The large funds claim that investors on AngelList lack sophistication or a true ability to support or identify genius founders. Ravikant is betting against that. He believes that venture capitalists should operate like software companies or service providers that are transparent about their pricing and their business models.

  AngelList is one of many digital means that founders are now using to raise capital online. Other platforms, including Kickstarter, SeedInvest, and Funders Club, aim to democratize fundraising and make the process more transparent and efficient. The change, however, has been slow. The vast majority of entrepreneurs I spoke with use these platforms to raise initial seed capital but often want the reputation of a large venture fund or the value-add platform services provided by funds such as Two Sigma Ventures and a16z. While traditional venture capital still dominates the financing market for entrepreneurs, one thing is for certain: AngelList and other platforms working to make the fundraising process easier for the entrepreneur have begun to crack the walls that VC funds have been hiding behind that purposefully make entrepreneurs jump through hoops to reach them and test their mettle.

  Blockchain & ICOs

  In his disruption of the traditional venture models, Ravikant has been a vocal proponent of how blockchain technology can enable founders to raise capital for their businesses. This movement began in 2013 and grew in popularity in 2018. Through Initial Coin Offerings (ICOs), entrepreneurs skipped the venture capital process all together and raised financing for their startups by offering tokens or coins to the public. ICOs were intended to be like IPOs in that it was a mass-market offering without the hurdles (e.g. paperwork, regulatory filings, roadshows, bankers, and other product approvals) of an IPO. In 2017, ICOs allowed founders to raise money by selling tokens or ‘coins’ as an investment in their blockchain project’s vision. Individuals invested in the digital rights to a venture, which provided access to goods or services provided by t
hat project, and the value of the token/coin fluctuated based on the performance of that company.

  While the concept is compelling to founders and offers an easier pathway to funding, most ICOs in 2018-2019 were fraudulent or junk. Still, these businesses raised millions of dollars overnight from both sophisticated investors and often unsuspecting individuals who hoped to cash in on a gold rush. For example, a developer launched a token called the XMAS token, which promised to bring gratitude and appreciation to the cryptocurrency (digital currencies) community. Other developers launched coins called “Useless Ethereum Token” as a joke, “Jesus Coin” as a religious token, or “DentaCoin” for the dental community. Investors poured into this asset class as two popular coins — Bitcoin and Ethereum — skyrocketed in value and minted hundreds of millionaires within under a year. In 2018, over $8 billion was raised in ICOs for over 1,200 ‘companies.’

  But the fortune and party for other investors was fleeting. The United States Securities Exchange Commission was slow to regulate the new technology and coin offerings. Thousands of household investors lost fortunes by speculatively betting on these non-traditional investments as the value of the coins tumbled in value. The value of Bitcoin and Ethereum (as well as XMAS Coin and Jesus Coin) dropped by over 75% between 2018-2019. These coin offerings demonstrated startup hysteria in its worst form. Inexperienced individuals who believed that ‘luck’ plays a big role in venture capital thought that they too could join the gold rush offered by early-stage companies.