Productizing Venture

A common trope about venture capital is that, while VCs only invest in businesses that use software, automation, and data moats, VCs themselves don’t practice what they preach with respect to their own businesses.

There are at least three big structural problems that have prevented the majority of VCs from productizing venture capital. 

First, most venture capital firms use antiquated business models that prevent them from being able to move quickly, reach scale, and establish strong competitive moats.

Most venture firms are built on a partnership model, like law firms. VCs are therefore often run by committee, instead of by a CEO. This leads to all kinds of incentive problems common with oligarchies, since it’s difficult for individual investors to make unilateral decisions — even when they have a lot of conviction about a startup.

Compounding this issue is the fact that VCs aren’t scalable. GP partnerships are highly time and attention constrained, making them the opposite of scalable. Most processes are run manually, and there is rarely much use of software or automation to help source, assess, or execute deals. 

Not only is it difficult for most VCs to scale, but when they do, it can have negative network effects. Many VCs claim that their craft doesn’t scale because more companies in a portfolio leads to less time to support each one and diligence future investments

Some VCs also believe that if you increase the number of your portfolio companies too much, it can dilute the value of your firm’s credentials — i.e. the self-fulfilling prophecy effect where the very act of a selective VC investing in a startup increases the likelihood that startup will be able to attract capital and talent. 

The second structural problem with the VC industry is that most venture firms are selling a product that is fundamentally an undifferentiated commodity — capital.

Despite what is often advertised, there is a lack of real support for founders beyond the fact that if you can get a VC with a good brand on your cap table, it legitimates your startup. This wasn’t always the case  — 15 years ago, the VC who sat on 10 boards had genuinely novel and useful information to share with founders like how to get to product-market fit, hire, run a sales process, fundraise, etc. But today, answers to 99% of startup questions are available via blogs, online content, or peer-to-peer founder networks. As a result, many VCs’ vaunted expertise has diminished in importance as a competitive advantage. 

This all means that VCs are selling a highly commoditized product (fundraising capital) to a limited supply of excellent founders — which does not make for a very good business model.

A third big issue in the venture industry is that most modern venture firms have broken incentive structures that misalign outcomes between GPs and LPs.

The first cause of this is that feedback cycles for venture investing are very long — it can take up to 10 years for a portfolio company to exit, and so in the meantime, the success of any given investment is generally measured by the size of uprounds. 

This faulty metric is only loosely correlated with the real quality and long-term potential of a company. It also means that venture investors are sometimes tempted to optimize for the investment appeal of a deal to future investors, not the long-term success of the investment. 

The other problem is that modern venture capital funds are incentivized to raise as much money as they can because of high management fees — the more money you raise as a VC, the more money you make, irrespective of how judiciously that capital is deployed. Traditionally, VCs take a 2% management fee every year for AUM, and a 20% cut of any upside. This incentivizes VCs to raise as much capital as possible to maximize management fees. For example, 2% of a $1 billion fund is $20 million revenue for a VC yearly — and with such long feedback cycles in venture, VCs with good sales skills can make a lot of money without ever being successful as investors, just by raising a lot of money from LPs.

This is a problem especially because the macro-economic environment is making venture more competitive over time. Low interest rates tend to drive more capital to riskier asset classes like venture capital, and there has been a 800-year-long downward trend in real interest rates. 

What this means is that an investor who would prefer to invest in bonds can no longer find any returns in the bond market and is forced back into public equities. This reduces the return of public equities and pushes traditional public equity investors, in turn, to seek alpha investing in private companies like startups. Over time, the net effect is more and more capital flooding into venture, creating greater competition and lowering the potential rewards of venture investing.

These structural problems in venture don’t just affect LPs and venture capitalists — they also impact startups and the health of the startup ecosystem overall. 

In particular, it makes it so that fundraising is still difficult for early-stage founders because VCs, beset with misaligned incentives, lack of ability to scale, and often relying on manual and outdated processes, don’t tend to do a great job of deploying capital.

For founders, fundraising can be very painful — often taking many months (the longer it takes to fundraise, the harder it gets), and usually involving a lot of rejection.

On top of this, it’s difficult for most founders to:

1. Identify the best investors for their company and evaluate investors’ reputations. Reputation also tends to be illegible, especially in niche communities like venture where you’re forced to rely on hearsay.

2. Get in touch with investors. Most VCs are faced with a constant barrage of inbound pitches, which makes it very difficult for quality founders to stand out from the crowd. As a result, many investors only respond to warm intros.

3. Get comps. It’s hard for most founders to see how investors’ terms of investment compare with each other, since there’s no open market for venture capital like there is for mortgages. Investment terms aren’t transparent and it takes insider knowledge to know what’s normal and what isn’t.

So it’s clear that the status quo of the industry is causing issues for startups and investors alike. What would it look like to take a product approach to try to solve some of these challenges?

What does productizing venture look like?

Productizing venture means taking everything that venture capitalists do — from sourcing companies to evaluating companies to adding value to founders — and using software or networks to do it better.

It means giving portfolio companies better tools for fundraising that help match founders with appropriate investors. One example of a VC product in this category is NFX’s Signal product. 

Hiring is another area of opportunity for productizing venture. One of the biggest constraints on building more breakout technology companies is human capital. Plus, the best talent is limited, meaning that with the proper network you can monopolize it for your own founders. VCs can help their founders get access to the best talent by building hiring marketplaces, communities, and even by manually introducing founders to key potential hires. On Deck does this by creating fellowships that serve as supply to founders’ demand.

Productizing venture also means helping founders source early customers, which reduces an important risk early on in a company’s lifecycle. A company's first customers are often the most difficult to source, and pre-product-market-fit startups need to talk to a lot of users in order to find initial product-market fit. 

Beyond value add to founders, productizing venture also means making venture more efficient in its sourcing and diligence processes. 

For sourcing, companies such as AL, Mattermark, Crunchbase, CB Insights, Pitchbook, and Product Hunt have proven that there is enough data to surface some % of startups launching every year.  

However, there’s an opportunity for software to look for startups before they launch by indexing people instead of companies — i.e. identifying all the founders who are most likely to start something in the next year, keeping tabs on them, and perhaps actively recruiting them to start a startup. For example:

• Acquired founders hitting 2-year marks. 

• Talented employees hitting 4-year vests.

• Scientists with high H-index

For automating and productizing diligence, firms like Correlation have used technology to augment or even automate parts of their investing process. Another example is what Social Capital tried a few years ago called CaaS, an automated online platform that allows you to upload transaction data and get a funding decision in a matter of hours through software, where founders can engage with a venture firm without a meeting. But since there’s so little data at the early stages, I’m dubious about software’s ability to help here beyond sourcing for relevant characteristics. 

Finally, productizing venture can help add value to LPs through productizing fund legibility. Typically, LPs have very limited information about how GPs are actually performing. For instance, it’s very difficult for LPs to see:

• What deals is a VC firm seeing or not seeing?

• What deals are they winning or losing?

• Is the firm investing out of conviction, or following other firms?

Today LPs look at things like follow-on investors to evaluate VCs, which is a lagging indicator of deal flow quality. While this is better than waiting for realized returns, it is still a very limited signal of VC performance.

Software could help LPs plug into GP deal flow CRM to better assess GPs’ deal flow and investment processes. This would allow LPs to better develop conviction early around emerging managers, which is super important because LPs typically have such limited information that they have to effectively commit to a second fund to evaluate if a VC is a long-term fit.

Software can streamline that process, allowing LPs to potentially decide after fund 1 if they should continue to work with a VC to manage their fund, while also reducing the amount of time and resources VCs must spend providing legibility for LPs.

Who today is productizing venture?

Venture today is already starting to productize, as indicated by some of the tools and features mentioned previously. Here are some (admittedly biased) examples:

• Tribe Capital uses data to inform investment decisions in early-stage startups. 

• We at Village Global by decentralizing venture, pushing decision-making to the edges to benefit from specialized expertise and networks.

• We at On Deck by creating fellowships that serve as supply to founder’s demand (for hiring, fund-raising, and customer acquisition), and then creates marketplaces on top of their fellowships to accelerate and scale the hiring, fundraising, & customer acquisition. 

While there are dozens of others productizing venture in their own way, as an industry we’ve barely begun to scratch the surface of what’s possible. Leading firms of the future will be productizing venture, and incumbents who don’t should view them the way Marc Andreessen once commented about Angel List in a New Yorker profile: “What if we’re the most evolved dinosaur, and [they’re] a bird?”

Thanks to Will and Sachin