For decades, the average investor could hardly obtain something besides stocks and commodities, and crowdfunding remained the most common avenue for regular founders.
Luckily, the venture landscape is transforming. There’s no more conventional wisdom on VC. Investing has come a long way from “male, white, and Ivy League-graduated” to a free-for-all activity.
But numerous challenges still remain. Diversity and inclusion are often just a marketing buzz. Laws recognize only “certified investors,” leaving a significant population without venture support.
From the moment VC emerged until the last decade, it was a tight circle of interconnected capital allocators who had the privilege to decide who receives the capital.
An experienced early-stage, cross-border venture capital investor Jonathan Tower highlights such stages of VC industry evolution: VC 1.0 (1960-2001), VC 2.0 (2001-2015), and VC 3.0 (2015-present).
The VC 1.0 firms often resembled law or consulting firms: everything was strictly hierarchical and looked like a club for “them.” This order fell apart after a recession in the early 2000s. The managers who got the boot from the whales dared to launch their own funds — younger, smaller, and more diverse, which caught the eye of emerging startups. Back then, technology was boosting business efficiency like never before, so young projects needed smaller, quicker, and easier checks. And the VC 2.0 firms were able to write them.
But the mindset more or less remained inside Silicon Valley until the middle of the last decade, when a newer generation of VC funds started to form. Since then, the VC 3.0 world has been presented in various forms, such as solo GPs, nano funds, angel syndicates, etc.
In other words, the VC industry has gone from big monopolistic brands created in the 1960s to feudal-like structures at the beginning of this century. And now, it’s facing yet another critical phase — decentralization — by switching the power of allocating capital from brands to individuals and communities.
The past of the venture capital industry reflects some significant drawbacks that all today's founders and investors are pained to recognize.
Yes, VCs still heavily rely on referrals. If you were not introduced by the right people — you go home. It’s super subjective, inefficient, and more like hitting the jackpot. At the same time, the next significant innovation can come from literally anywhere.
Despite all the brouhaha, the diversity gaps continue to exist. We all hear established VCs declaring, “We’ve promoted X females to partners.” But the overall picture is that most venture players are white men — choosing to reward their likes. Shockingly, in 2022, only 2,1% of funding went to startups led by women, Pitchbook says. And a mere 2,5% was allocated to Black and Latin founders, as noted by Crunchbase.
Herd instincts rule people; we tend to invest in things that receive the most hype rather than what benefits society. That's why it's crucial to have a greater diversity of people managing finances so that we don't end up in situations where nuclear power receives $3.4B while grocery delivery services get $18.5B.
Years go by, but companies remain way longer in the hands of VCs. Apple went through an IPO just four years after its formation. Now projects stay private much longer — on average, over 10 years. The public is offered to enjoy investing in innovative ideas only when all the cherries have been picked, and getting a high IRR is no longer possible.
If the current VC industry fails to change, it becomes inherently unsustainable. It will gild fleeting trends while overlooking the disruptions. That means wrong predictions and wrong bets, just like what the founder of Fox Broadcasting, Barry Diller, did.
He once said, “People with talent and expertise at making entertainment products are not going to be displaced by self-producers coming up with their videos that they think are going to have an appeal.” The exact same year, YouTube appeared.
The good news is that we've got enough to turn things around for the better.
First of all, there is no scarcity of startups. Launching a venture business keeps getting cheaper; with all the cloud services, no-code solutions, and AI tools, anyone can potentially build something people want. Sometimes — in just a matter of weeks.
Moreover, founders continue to raise more and more money despite the global economic crisis. And the value of their projects is steadily growing; thus, the European startups’ total valuation is above $3T. For comparison, their capitalization in 2020 barely exceeded $2T, Dealroom and Silicon Valley Bank counted.
Second, more founders-led capital is yet to come. The world is gaining more and more founders, operators, and tech influencers who are breaking into the venture business as first-time fund managers. While some of them might be structured as solo GPs, angel funds, or even family offices — the way they operate is pretty much VC-like. That’s what we’ve been seeing in the US for quite some time, and this is something that we’re definitely going to see in Europe.
Ironically, despite the lack of experience and resources, such newcomers outperform their established peers who have been hustling for decades. According to Preqin, emerging managers with less than $100M made a 20% IRR along with moneybags owning $1B and earning only 2,4%.
A question arises, how do these tiny creatures actually manage to beat the elephants?
They invest early in emerging verticals and models, discover untouched sourcing channels, and use innovative data-driven diligence approaches.
New venture players are laser-focused. They are not “a place for future technologies” but “represent Austrian female founders building B2B Fintech.”
When you start from scratch, you don’t have legacy issues. Take 400 emerging funds launched in the last 3 years — 100 of them have female managers, and 25% were in it from the very beginning.
Founders admit that working with new VC managers is more like working with an angel investor who writes hefty checks and brings more potential value down the line.
As scaling founder Christiaan Oosterveen says, “Microfunds are the biggest opportunity any ecosystem has to develop their talents into startups. Sometimes it only takes a €50,000 bet to build a €1M+ business. And even better, it doesn't take 10 years for a fund to reach 300% but just 5 years.”
The smaller the fund, the easier it is to make early bets and outperform. A single outlier has the potential to generate solid fund-level performance, while a larger fund would instead go to later stages, where the upside is much more limited.
Obviously, it can not be done without drawbacks. First-time managers can only rely on their network: that means high risks, no access to institutional money, and blind regulations which do not allow them to advertise publicly.
But the ice started to break a couple of months ago when the European Commission amended the “European Long-term Investment Funds” framework. This was the first time European regulators realized that venture capital must be available to retail investors. If the trend continues (and it will), it will be a game changer.
I believe that over the next decade, atomization will unfold massively, and individual investors will play a much more significant role in building and growing companies.
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