Decentralizing Venture Capital
Aligning knowledge and power to make better investments
|Erik Torenberg||Nov 30, 2020||12|
Hey everybody, it’s Erik Torenberg — co-founder & partner of Village Global, a network driven venture firm.
If you’ve listened to Venture Stories, you’ve heard me say those words once or twice.
But what exactly is a network driven venture firm? Isn’t every firm network driven? I mean, everyone’s scrambling to meet founders, build their network, and hopefully invest in the next big thing. While that may be the case, we at Village Global think of our fund through the lens of “decentralizing venture,” in an effort to align knowledge & power.
To better understand what this means, let me briefly summarize tthe book “Knowledge and Power” by George Gilder:
In primitive societies, people were self-sufficient. They gathered food, made clothing, and found shelter. Today, no one’s self-sufficient. They’re specialized. Everything you consume — you couldn’t produce it even if you tried. Your daily life depends on the cooperation of millions of others.
Imagine making, say, cereal from scratch. You’d need to grow the grains yourself, which would mean making tools, which would mean mining metals, which would mean finding metals, which would mean building machinery… You get the idea.
So how does the cereal we eat get created? Markets. And more specifically, the entrepreneurs within. Entrepreneurs constantly test new types of specialization, and markets determine which specialization prospers and which dies. This isn’t dictated by a central planner, but from the decentralized actions of many founders testing ideas in search of profit.
But the notion that markets define technology — that demand creates supply — is a fallacy that leads to meddling in entrepreneurial activity. While government power can increase the money supply, it can't enhance the inherent value of that money. Value is an expression of entrepreneurial knowledge.
So the key issue in economics is not aligning incentives with some putative public good, but aligning knowledge with power. Business investments have both a financial and an epistemic yield. Capital is not merely a flow of power, but also an accumulation of specific knowledge.
Take capitalism for example. Capitalism is a knowledge system that preserves the experience of entrepreneurs by allowing them to continue their work and expand their investment if their project succeeds. It aligns power with knowledge. Perhaps this will make more sense to some if we look at the converse. Take the 2008 financial crisis. Innovative financial instruments were understood by financial engineers (they had the knowledge) but not by executives, policymakers, and regulators (who had the power) — in 2008, knowledge and power were misaligned. Dangers arise when the people with the most data and knowledge are the furthest away from the decision.
Let’s apply this to venture capital:
To zoom out: You’d think that venture capitalists would be, well, capitalists. Indeed, VCs say they love free markets and capitalism, but in practice they run their businesses like central planners: it’s just a handful of partners at HQ deciding investments across a dizzying number of sectors and geographies and technologies, all based on highly incomplete and imperfect information. It’s like the central government trying to centrally determine the price of a loaf of bread.
Venture Capital? More like Venture Soviet Russia!
Let’s back up a bit. In the early days of high tech venture capital, decentralizing information-gathering wasn’t always so important. Just as one person could have understood all of what was known about physics at one point in time, it was once possible for one person to specialize in “internet investing.” Remember the days of John Doerr and Mike Moritz doing all the important internet deals?
As the internet has transformed every industry, it’s become clear the world of “software” is too complex for most generalist software investors. So VCs have increasingly moved themselves to the edges of specific networks — and focused their decision making in that one area. Today there are sector focused funds covering everything from fintech (Ribbit) to real estate tech (Fifth Wall) to SaaS (Point Nine) to construction tech (Brick & Mortar). There are even specialized funds within specializations. Crypto, for example, even in its nascent stage, has dozens of sub categories, requiring corresponding areas of expertise: law, game theory, engineering, math, finance, social science. We don’t just have crypto funds like Polychain or Pantera; we have DeFi focused funds (Framework) or privacy focused funds (Scalar Capital). Or in the digital health and biotech arenas, we’re seeing increasingly focused funds like Longevity Fund that focuses on — you guessed it — longevity. By the way, in the nine years since Longevity Fund launched, there are now multiple additional funds competing in that same niche.
As the art of building world changing companies has been codified and made more scientific, some investment managers have chosen to slice up the complex world not by sector but by functional and operational expertise. GPs now sell expertise around talent (Sweat Equity), design (Form Capital) and product (Chapter One) in their specialized venture funds.
Finally, some VCs have sought to develop expertise not based on the sector of the startup nor the functional area they believe matters most but by the network the startup entrepreneurs bubble up from. The simplest example of this is geography. In the seed market, Notation covers New York, Wonder covers LA, Next View covers Boston, etc. The harder-to-track version of this is covering specific social networks: Lachy Groom targeting the Stripe mafia (that is to say, ex-employees of Stripe who start companies) and Wave Capital the Airbnb Mafia.
Specialization has its challenges...
The challenge with the trend of specialization is that it forces the GP to make public bets on very particular trends — and even if you think you can see the future, nailing when certain technologies will hit the mainstream is not so easy. VR/AR focused funds that launched a few years ago (we won’t name names) were a bit early to the party, for example.
To acknowledge the follies of trying to boil the ocean takes humility. But to then declare that you can identify the one trend within this ocean of possibility that will matter most over the next 10 years — that’s a bit less modest.
Specialization can also prove limiting for managers who aspire to run large AUM franchises. Forerunner Ventures rose to acclaim by its focus on consumer-brand oriented businesses like Glossier and Away. It was a sector niche. Their most recent fund size is $500 million and they’re now broadening into new, non-consumer categories. Their task is now to evolve their brand identity accordingly.
Village Global’s approach
At Village Global, we’ve built our strategy to be both generalist and specialist within a market-oriented, semi-decentralized structure. We’re bottoms-up in our development of investment theses — which is to say, we will back founders’ visions for building a new and better future wherever those convictions take them: enterprise SaaS, robotics, fintech, digital health, and more. We maintain no theology on particular sectors or technologies.
At the same time, we leverage specialized networks to source, select, and support unique deal flow within 25-30 flows that we, the GPs at Village Global HQ, help define. It starts with our luminary LPs who often are among the most powerful players across several meaningful industries: from financial services to healthcare to AI to supply chain logistics to consumer social networks. We then recruit and engage experts by sector, function, or geography. We empower these folks to find the smartest founders working in these general domains, and then, using Village’s capital, they back the founders before anyone else does. The agility of our model allows us to add new Network Leaders easily to cover emerging areas, even within a fund cycle.
We believe we’re aligning knowledge and power across our Network Leaders and championing a market-first orientation to how to practice venture. We think it’s the only way a firm can be generalist in its thematic theses and still smart enough to bet on the right founders at the right time.
Thanks to Ben Casnocha for meaningful contributions to this piece.
Village is currently accepting new founders into the Village Global Accelerator, where you’ll be paired with a Network Leader for hands-on support though a 12-week program, as well as investors & a Head of Legal Ops at Village Global HQ. If our mission resonates with you, as a founder or as an investor, come join the Village! Apply for our accelerator here, or learn more about our open roles here.
Read of the week: On Being Authentic by Charles Guignon. Referencing Charles Taylor, Lionel Trilling, Alasdair MacIntyre and others’ work, Guignon shows how authenticity as a concept has evolved over time.
Listen of the week: Shelby Steele on Glenn Loury.
Watch of the week: Charles Taylor and Jonathan Sacks on The Future of Religion.
Until next week,
P.S. Happy Thanksgiving! I share with you my favorite gratitude quote, by Sam Keen:
"Notice that the more you become a connoisseur of gratitude, the less you are the victim of resentment, depression, and despair. Gratitude will act as an elixir that will gradually dissolve the hard shell of your ego — your need to possess and control — and transform you into a generous being. The sense of gratitude produces true spiritual alchemy, makes us magnanimous — large souled."