The Next Big Thing in VC
The Next Big Thing in VC
“What’s the next big thing in VC?” Whenever I see a VC from the states or even from the region, I ask this question, but none of them gave me a satisfying answer. I will share my answer here and hope that this will stimulate others to comment with different point of view.
Before discussing the next big thing in VC, let’s go through what happened and happening right now in the international VC industry, then try to expect what may happen in the future.
What Characterizes the Current International VC Scene?
1. Faster Exits
In the past 3 years, we have seen international startups having much faster exits. As an example:
- BetaWorks had 3 exits after only 3 years of starting their fund! In their first 3 years, they return their $26m fund and some extra even before the fund term!
- TwitterFeed acquired by bitty
- TweetDeck acquired by Twitter
- GroupMe acquired by Skype
- Troika Ventures has achieved a 10X exit in 3 years time. It has sold its shares in Evernote to Sequoia Capital. An investment of $4.5m returned $45m in 3 years.
2. Active Private Capital Markets
In addition, Private Capital Markets are growing to create new exit opportunities on which Facebook, Twitter, DropBox, Yelp, and many other companies are being traded daily. The most famous exchanges are now:
3. The Rise of Accelerators
In the past 5 years, the concept of Accelerators was booming. It all started with “Y-Combinator” who wanted to create a special value-add incubator that accelerate the process of taking a company from idea stage to the beta version stage. Accelerate the process of creating a proof of concept.
This innovation was followed by many others who added more value and focused more on mentorship such as:
Then we started to see vertical or thematic accelerators suc as:
- TechStars Cloud: focused on startups in the cloud computing and cloud infrastructure field
- FinTech Innovation Lab: focused on startups creating new consumer financial services
- StartAppz: focused on startups creating innovative mobile applications
Those are all acting as “Public Accelerators”, meaning that anyone can apply to get funded and incubated there. However, this stimulated the idea of “Private Accelerators”, or what’s so called “Labs”. A twist to the old “IdeaLab” concept, where ideas are generated internally, and put on an acceleration mode before they are nurtured or killed.The biggest examples of this is are:
4. Changes in the VC Model
The “Accelerator Fund” model was a revolutionary concept that challenged the traditional VC model. It also proved that startups, especially web and mobile ones, need less time and less money to kick-off, and sometimes, less time and less money to get an acquisition exit, eliminating the role of the growth stage VCs!
8% of TechStars startups were acquired after getting a small series A fund. The majority of those startups received an average of $0.5m as a second round, then they were directly acquired! For example:
- SocialThing: Received few thousands from TechStars, then $0.5m from early stage VCs, then it was acquired by AOL
Big VC firms are now struggling to capture big opportunities early enough to make big returns. So some of them such as Polaris Ventures started its own public Accelerator-like environment (DogPatch Labs), for free, to get access to smart entrepreneurs from the very beginnings.
However, if not acquired, but still active, such startups usually reach the growth stage, which nowadays require more funding than ever! For example:
- DropBox: Received few thousands from Y-Combinator, then $1.2m, then $6m, then $250m from a group of top US Growth VCs!
So the need for growth stage VCs is still there, and needed more than ever in later stages.
The Next Big Thing in VC: Revolutionizing the VC Model
1. “Elevators”
The current market situation has created an opportunity for a new class of VC funds that takes graduates of Accelerators and “Elevate” them to either acquisitions or to next growth stage VCs. Such post-acceleration funds can be called “Elevator Funds”, “Business Elevators”, or simply “Elevators”.
In a semi-accelerator-like environment, Elevators would invest at a standard deal an amount of $0.5m for a standard equity percentage. But unlike Accelerators (that have batches and a fixed 3 months term), Elevators will have no batches and no fixed investment term. The $0.5m might be enough to fund the startup for 6–18 months based on the founders’ choice. The investment period will be flexible to welcome acquisitions or next investment rounds at anytime as well.
2. “Carry Options” for Entrepreneurs
The founders of a startup usually offer “Stock Options” for their key employees to motivate and retain them. In a VC fund, VCs, may offer their investees (or entrepreneurs) “Carry Options” to encourage them to share knowledge and lessons-learned with each other within the same fund. This will also encourage them to join forces, merge, collaborate, or even join each other’s startups if one of them fails.
In addition, Stock Options in startups are used to face the “High Salaries” competition over talents. Employees agree to get lower salaries for a stake in the startup. In VC funds, “Carry Options” will be used to face “High Valuations” Competition! VCs will not be able to keep competing on valuations for ever, and entrepreneurs might accept lower valuations for a stake in the fund’s returns.
3. “Capture Capital”: Shorter Funds with Non-liquid Returns
In such market dynamics, where investment needs for seed stages are much less than ever, where exponential valuation increments can be reached within shorter periods of time, where acquisitions can be achieved much faster, and where private capital markets can be utilized as a backup for quicker exits, then, fund lifetimes can be much shorter, as short as three years.
Moreover, as opposed to cash returns in traditional funds, where all investments should be exited and/or liquidated at the end of the fund lifetime, new shorter funds can return “Higher Valued Equity” that will be validated by attracting next rounds of investments from top tier VCs. So “Successful Startups” will be defined as startups who receive next investment rounds from a top tier VC and/or get acquired (if any).
So that at the end of the fund’s lifetime, the fund’s equity in its successful startups (who receive next rounds from other VCs) will be distributed to the fund’s investors (LPs) pro-rata including fund managers. This is of course if the investors who participated in the fund want to stay as shareholders in selective successful companies.
If not, then selling the fund’s shares in successful startups at secondary (private) capital markets can be used to liquidate the fund returns at the end of the 3 years in order to get cash returns, but who wants to exit a startup that receive a big check from a top tier VC firm?!
In other words, the fund’s mission will not be achieving big cash returns. The fund’s mission will be capturing good deals, get you in it early enough, and help elevate them to the next stage. This might be called “Capture Capital” instead of “Venture Capital”, and people who work in “Accelerators” and “Elevators” can be called “Capture Capitalists”.
4. Cafe Startups
In the past, startups started from garages. Apple, Google, Amazon, and many others started in their own small garages. While nowadays, startups start from Cafes as they are more comfortable, served with food and beverage, more fun, and can accommodate founders and their small teams for a much longer time period.
Cafes are being used by Lean Startups to reduce the seed investment needed to take startups to the next level. Cafes eliminate real estate, furniture and decoration expenses for offices, which can eat a big chunk of the seed investment, especially in the “Elevation” phase. Investments can be effectively utilized in team building, product development and marketing.
So “Elevators” might better encourage startups to work from Cafes in the first 6–18 months, until they receive the next round’s big check.
If you read all the above to this point, then you are really interested, let me know what do you think?
