Venture capital is an exciting field, but recent fundamental trends in money inflow/outflow suggest that passive VC investing may not work for very long. Certainly, early stage startups have been hard put to find funding.
In the last ten years, the amount of capital raised has been quite impressive:
More capital meant more deals and larger check sizes; thus, both the total deal count and deal value have both grown quite significantly over the last decade. This has pulled up the median deal size in early stage investments, allowing the average US VC deal size for early stage ventures to more than double – from about $3 million in 2009 to $6.5 million in 2019.
However, the number of exits hasn’t exactly grown at the same pace. Between 2012 and 2019, the annual exit count exceeded 1,000 only during three of the eight years in that period; moreover, the 2019 exit count has not changed much since 2012.
Clearly, even though more money has flown into venture capital and more money has been invested into each deal, the number of exits hasn’t kept pace with the growth in the inflows. The value of the exits has gone up suggesting that fewer companies account for a larger chunk of the total exit value.
Given the current state, to continue with the conventional way of taking a minority passive position in an early stage venture and then, waiting for a liquidity event may not give you a reasonable risk-adjusted return. The entry itself is getting more expensive and the exit more challenging. Perhaps, a venture development model is what investors need to adapt to these industry-wide developments.
What is the Venture Development Model?
The venture development model lets investors focus on businesses that have smaller funding needs, thus, finding greater opportunities to make better returns, shape the strategic direction of the invested company, and save some significant costs along the way.
You can get founder level equity
Through venture development, the investor can get in early and at a stage when funding requirements and the need for large funding rounds is low. In exchange, the funder is able to acquire a high stake of ownership. Moreover, the chances of making high returns are more likely even with an average exit.
You can position for the all-important liquidity event
Most of the time, the venture development team will either assume roles that steer the organization or otherwise, will sit in the Board. By playing a more active role, the investor can influence or shape the strategy of the business and usher the startup towards an eventual sale or for an IPO.
You can save costs
Investors can apply some control or at least make recommendations over how startups should manage their funds. For example, the startup can be located in a low-cost area. rather than at a traditional hotspot like California and New York, thus saving overhead expenses.
Costs can also be saved by working with university labs, for example, in the heartland of America. Many investors have leveraged the lower cost structure of such mutually beneficial arrangements. Rather than pouring money into developing new technology from scratch, funders can create incentives for faculty, graduate students, and undergraduate student- researchers to develop high-potential technologies that can be eventually commercialized.
If done correctly, venture development can be an interesting and effective way of making successful investments in early stage ventures. At a minimum, investors can avoid the risk of overpaying for a particular investment and end up finding only limited opportunities – a rather quick way to hurt the return ratio.