The wind of change is blowing across Venture Capital. Not confined to a specific market or geography, the relationship between VCs and the companies they invest in has shifted culturally and economically.
There is a sense that models are in need of a change to safeguard otherwise resilient sectors such as tech from the fated ‘bubble’ scenario that many sceptics see on the horizon, and with this, the deal structures and ultimately ROI is also changing. With a series of disappointing, or worse still, failed tech IPOs hitting the market over the past year, a rather grey cloud is beginning to shadow the world of start-up financing. You needn’t look far to see how even the biggest names in the market have got it wrong; Uber, Lyft, Slack, and Spotify are all trading way off their initial listings – which for their venture backers isn’t boding well for forecasted targeted IRR. This comes at a time when funding start-ups is now arguably more capital intensive than it was five years ago. At the same time, the millennial entrepreneurs at the helm are changing the business founder image, and VCs have been forced to adapt how they operate – after all it is the entrepreneur they serve, right?
So what is changing, and how are VCs adapting to keep pace with the evolving landscape to ensure consistent, whilst at the same time ‘market beating’ returns for the LPs and institutions who comprise many of the large VC funds?
The tech sector and more specifically AI is an immense market opportunity for innovative start-ups and their VC backers. However, over the past five years there has been a flood of companies launch very similar products and services, and ultimately not all of them will become the next Deepmind. Therefore it’s necessary to carry out even more extensive due diligence ahead of any funding offer, with a growing number of VCs hiring domain experts who really understand what they’re looking at – less of the shooting from the hip style of screening and more of the detailed data and technology analysis.
Until more recently, it was possible for many funds to provide returns to their investors with a five to ten year horizon due to the sheer volume of capital hitting the market, and the relatively short time needed for many start-ups to scale to a point of acquisition or IPO. However, with the number of unpalatable public listings of late and the rhetoric of the tech sector ‘bubble’ perhaps deflating slightly if not fully bursting, investors will need to be willing to sit on their returns for a while longer. As markets regain confidence and corporate investments and acquisitions gain further pace, selling out too early due to a fund cycle could mean leaving a lot of value on the table. Many are now eyeing a long-term approach to maximise returns, and so there will certainly be more funds set up to do so over a longer time horizon.
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Author: Daniel Pitchford