Differentiation
Venture is homogenous, but not for long
TLDR: A profitable core spins your flywheel faster
Venture capital is essentially homogenous.
Raise money, take a 2% management fee and 20% of the profits, deploy it better than anyone else, and if you’re in the top quartile you’re still only returning ~3x over 7-10 years. Meanwhile the S&P, a liquid index, is up 2x in just the past 5.
Let’s set some context…
Let’s say for example you raise a $100m fund. Your 2% fee is $2m in operating capital. With that money you not only need to pay salaries, source companies, and win deals, but you need to do all of those things better than your peers with essentially the same resources.
Enter the platform team. A loose term for value-added services—marketing and recruiting for example. A way to not only attract great companies, but help them to grow too.
But how do you pay for that? You need more management fees, so you raise a bigger fund.
But now that you have a bigger fund, you also have to deploy more capital. How do you find a greater volume of truly great companies? Compete for deals with larger checks and sexier valuations.
I think that’s one reason we’re seeing literal insanity in venture right now. Take JOKR for example—raising $170m in just 100 days.
There are two sides to this coin.
On the first, there are those that believe big checks enable companies to hire the best people, and that doing so not only improves the company itself, but speeds up the return and reduces the downside risk through acquihire value.
On the other, big checks cause companies to act inefficiently, lose their focus, and struggle to build enduring companies (a la Quibi or WeWork in the most extreme examples).
So how do you create differentiation in today’s venture world?
My bet is simple.
Increase operating capital without increasing management fees.
But how?
Leverage the fund’s assets to derive short-term profits to balance the long-term venture gains. The long-term gains are what truly spin your flywheel, but as you wait for those companies to mature and those exits to happen, you can continue to strengthen your core.
Doing so results in the latitude to build outsized resources relative to the fund’s size.
In order to do this well, my belief is that the business created to drive short-term profits must meet a few principles:
The business must be in direct alignment with the core focus of the fund and the value must flow freely between the portfolio companies, the clients, and the fund operations as a three-sided ecosystem
The business must be bootstrapped and high-margin so as not to detract from the core nor require additional financing
The value created for customers must be demonstrably higher than their investment, with systems in place to ensure prioritization of the fund’s core > profits
By increasing operating capital without increasing fees, the fund can maintain an incredibly high bar for the quality of company they invest in, modernize their technology, pay higher wages to top talent, and build resources for their portfolio without over-diluting founders in their earliest rounds.
That is how you create differentiation in venture, by not just saying you are better at picking companies or touting your networks, but by objectively building a stronger fund through technology, talent, and capital.
You’re probably wondering what kind of business that would be, but we’ll save that for another time.
See you Monday.