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How Jordan Nel Spots Winning Venture Funds

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Claude Grunitzky on Democratizing Access to Venture Capital

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Tomasz Tunguz and David Clark on how to invest in AI and Q1 2024 startup valuations

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📖 DEEP DIVE

4,000 VC Firms - Are we in a VC Fund Bubble? 🤨

The venture capital ecosystem has undergone a significant expansion in recent years. Once a relatively exclusive domain with a limited number of participants, the industry now boasts a considerably larger cohort, with estimates placing the number of VC firms between 2,000 and 4,000. This growth poses a question – does this growing landscape signify a positive development for the industry, or does it present challenges?

Correlating Startup Proliferation with Increased VC Activity

A key factor driving the growth in VC firms is the explosion of investable startups. The fundamental principle is one of supply and demand.  Consider a hypothetical ecosystem with 1,000 viable startups seeking venture capital. Assuming an average portfolio size of 20 companies, the ecosystem could theoretically support approximately 50 VC firms (1,000 startups / 20 portfolio companies). However, if the number of investable startups increases tenfold to 10,000, the ecosystem could now potentially now accommodate 500 VC firms (10,000 startups / 20 portfolio companies).

Diminishing Barries to Entry: Fueling the Startup Surge

The dramatic rise in startups can be attributed, in part, to the dismantling of traditional barriers to entry.  Historically, launching a company demanded substantial capital – in the 1990s, the average startup required a staggering $5 million. The 2000s witnessed a reduction to $1 million, and the 2010s saw a further decline to $100,000. Today, the barriers to entry are approaching $0.

This revolution can be largely attributed to the transformation of computing costs.  Gone are the days of exorbitant, fixed-cost server purchases. Today's cloud-based solutions, exemplified by Amazon Web Services (AWS), offer flexible, variable-cost models where companies can rent individual compute units as needed.  Additionally, the proliferation of developer tools and movements like low-code/no-code development have significantly reduced other startup costs.

This convergence of forces has ignited a global wave of startup creation, which in turn, has fueled the emergence of a vast pool of new VC firms, often led by exciting new players.

Industry Expertise and Operational Efficiency

1. The Rise of the Operator-Turned-VC:  Seasoned industry veterans, armed with deep domain expertise, are increasingly making the leap into venture capital. These "operator-turned-VCs" offer a unique perspective, having navigated the challenges of building companies firsthand. This invaluable experience positions them to make well-informed investment decisions and provide exceptional guidance to the founders they support.

2. Democratizing Fund Administration:  Tools like Carta, AngelList, and Sydecar have revolutionized fund administration.  Previously a manual, expensive process requiring dedicated staff, these solutions streamline the process, making it more accessible and cost-effective for new VC firms.

Implications for Stakeholders: A Mixed Blessing

The burgeoning presence of 2,000 emerging managers presents a complex landscape with both benefits and drawbacks depending on the stakeholder.

For entrepreneurs, the new landscape offers a diverse pool of potential investors to choose from – large multi-stage VCs, individual angels, micro VCs, corporate VCs, and the list goes on. Each player caters to specific investment stages, offers unique value propositions, and fosters a truly dynamic marketplace.

Limited partners (LPs), the providers of capital for VC funds, can benefit if they possess the systems and expertise to navigate this new environment. Savvy LPs can leverage the abundance of emerging managers in order to lock in superior returns.

Challenges and Opportunities for Emerging Managers in a Crowded Landscape

One potential group that has been hurt by the boon in emerging managers is emerging managers themselves.  This is because in bear markets such as today (2024 VC fundraising is on pace to be the lowest since 2015) many emerging managers are unable to raise a critical amount of capital in order to make this career choice viable. 

Even when emerging managers may reach their “minimum viable fund size” it may still not be compelling enough for an emerging manager given that emerging managers tend to be talented professionals with high career opportunity costs.

Conclusion: A Maturing Ecosystem Demands Strategic Navigation

The VC landscape is undergoing a period of significant transformation, brimming with both potential and challenges. While the influx of new managers presents exciting opportunities for founders and sophisticated LPs, navigating this evolving ecosystem will demand a discerning eye, a well-honed strategy, and a deep understanding of the dynamics within the industry. Until then 🫡

✍️ DAVID’S BOOKMARKS

• Tiger raises $2.2 Billion - 63% below target 🙀

• Cendana and Kline Hill team up to buy secondary stakes from weak hands 🚀

• Peter Walker breaks down startup employee equity refreshes 💵

📈 CHART OF THE WEEK

🛠️ EMERGING MANAGER TOOLS

• Chris Harvey for fund counsel 

Reach out to Chris at [email protected].