Really fun article that brings a lot together. Two comments... the math in the Puritans section mixes asset class and individual firm data. -> If a unicorn is 75% owned by "VCs as a class" at exit (more likely than Freds 50-60% for the firms that have later, bigger exits) then $150B as-a-class and 3X goal as-a-class means VCs need $600B exits as-a-class (not $2.2T). But I agree it is still Mission Impossible, startup exits are well below 600B most years (except 2021).
Second, more on portfolio construction... its muddy to say that "cottage wants 10X while aggregator wants 3X". OK yes.... but the target return must be adjusted by stage. Really both want 10X *per seed deal*, both want 2X *just before IPO*, and both want to give LPs 3X *as a fund*. The difference is that Cottage typically does not have late stage dollars to invest, so they must price Seed/A low enough get 10-20X on winners and hit 3X as a fund once a bunch fail. Whereas, Aggregator puts the vast preponderance of its money into late stage after winners are known. They can afford to overpay at Seed as a loss leader and earn profit later.
Its not really a free lunch for founders... they can get a better price in Seed/A from a big fund, albeit with less partner-level support, but they may pay the piper in middle rounds as they have to contend with the signaling effect, which gives the big firm who is already on the cap table considerable negotiating power.
Overall the late-stage scale gives a clear early-stage edge for big firms... on any normal business where the needs are predictable (and can be served by platform machine rather than a partner). Whereas Cottage wins when the startup does NOT fit a standard mold and *does* need close partner attention early.
As a student, this was a very educational read. The simplicity of covering the history of why these two types of firms were born and how they coexist was great.
I understand the point that LPs don't want to be invested in 1k+ firms and rather cut the number down by 10x size checks, however do these shark LPs have employees to scout firms and deploy their capital / via their FOs? If so, why would they cut larger check sizes with an expectation of 20-30% of the returns they would expect on lower check sizes, when they could hire a few more people to scout these firms? (or is it because of a lack of that high volume of good firms)
Great article! I would wish to understand better the founder perspective of having received funding from each strategy and what outcomes have resulted from their perspective
Does the extract below assume that the risk of an S&P 500 investment is the same as the risk of a VC investment? I’d think that the minimum threshold return required by an LP from a VC investment would be higher than 2x given the higher risk compared to an S&P 500 investment.
“If you'd invested $250M in the S&P 500 5-10 years ago you would have generated ~12.7% per year, or a 1.6x return. The longer, the better. So your threshold is ~2x for a venture fund with 5-7 year lifecycles, because that would be ~1.6x net of fees. That's it! Big capital agglomerators working with big LPs can promise 2x funds, and the business model in that particular equation can work.“
What happens if the next generation of founders and companies don't need as much capital? What happens if the next generation of founders once released after the coming toilet flush, who had underwater stock options remember the lessons and mistakes of their bosses. What happens if the new generation of founders realizes that economic alignment between the agents and actors makes a difference?
Great article. It would not be a good thing for the innovation economy if there were just few dominant capital providers and gatekeepers.
Amazing post Kyle
Really fun article that brings a lot together. Two comments... the math in the Puritans section mixes asset class and individual firm data. -> If a unicorn is 75% owned by "VCs as a class" at exit (more likely than Freds 50-60% for the firms that have later, bigger exits) then $150B as-a-class and 3X goal as-a-class means VCs need $600B exits as-a-class (not $2.2T). But I agree it is still Mission Impossible, startup exits are well below 600B most years (except 2021).
Second, more on portfolio construction... its muddy to say that "cottage wants 10X while aggregator wants 3X". OK yes.... but the target return must be adjusted by stage. Really both want 10X *per seed deal*, both want 2X *just before IPO*, and both want to give LPs 3X *as a fund*. The difference is that Cottage typically does not have late stage dollars to invest, so they must price Seed/A low enough get 10-20X on winners and hit 3X as a fund once a bunch fail. Whereas, Aggregator puts the vast preponderance of its money into late stage after winners are known. They can afford to overpay at Seed as a loss leader and earn profit later.
Its not really a free lunch for founders... they can get a better price in Seed/A from a big fund, albeit with less partner-level support, but they may pay the piper in middle rounds as they have to contend with the signaling effect, which gives the big firm who is already on the cap table considerable negotiating power.
Overall the late-stage scale gives a clear early-stage edge for big firms... on any normal business where the needs are predictable (and can be served by platform machine rather than a partner). Whereas Cottage wins when the startup does NOT fit a standard mold and *does* need close partner attention early.
As a student, this was a very educational read. The simplicity of covering the history of why these two types of firms were born and how they coexist was great.
I understand the point that LPs don't want to be invested in 1k+ firms and rather cut the number down by 10x size checks, however do these shark LPs have employees to scout firms and deploy their capital / via their FOs? If so, why would they cut larger check sizes with an expectation of 20-30% of the returns they would expect on lower check sizes, when they could hire a few more people to scout these firms? (or is it because of a lack of that high volume of good firms)
Thank you Kyle!
Great article! I would wish to understand better the founder perspective of having received funding from each strategy and what outcomes have resulted from their perspective
Does the extract below assume that the risk of an S&P 500 investment is the same as the risk of a VC investment? I’d think that the minimum threshold return required by an LP from a VC investment would be higher than 2x given the higher risk compared to an S&P 500 investment.
“If you'd invested $250M in the S&P 500 5-10 years ago you would have generated ~12.7% per year, or a 1.6x return. The longer, the better. So your threshold is ~2x for a venture fund with 5-7 year lifecycles, because that would be ~1.6x net of fees. That's it! Big capital agglomerators working with big LPs can promise 2x funds, and the business model in that particular equation can work.“
Really enjoyed this one. It pulled together a lot of threads I have been thinking about.
Thanks for sharing. I think the middle ground will (quickly by VC standards) become empty as we have seen in so many other sectors.
What happens if the next generation of founders and companies don't need as much capital? What happens if the next generation of founders once released after the coming toilet flush, who had underwater stock options remember the lessons and mistakes of their bosses. What happens if the new generation of founders realizes that economic alignment between the agents and actors makes a difference?
Great article. It would not be a good thing for the innovation economy if there were just few dominant capital providers and gatekeepers.
This is an exceptional post. Really thoughtful and comprehensive.
I wonder where the middle will go. Maybe to emerging markets.
This is phenomenal. One of the best posts I’ve read about venture at large.
Just amazing. I learned a lot. Thanks a million!
what a great read!
Wow! Well done! Amazing article