Intel updates - Euro Intel

Where is the VC market going

Euro Intel 09 September 2021

Venture capital firms are usually competing by outdoing their peers in the same activities in an incremental way. But they never did things their competitors aren't doing. Now, that we have a hyper competitive environment, where is the market going and what are some structural problems ahead.



I was reading about how a16z is outperforming everybody in the businesses by setting up their own path and not doing what everybody else is doing:

Venture capital investors are big fans of the word "strategy," but they hardly give it much thought in their own business. Historically, venture capital firms competed by outdoing their peers in the same activities in an incremental way. But they never did things their competitors aren't doing.

Been saying the same for quite some time now (12), money is cheap and the VC business is being commoditized, we're going through a hyper competitive period in the private investment business, with blurred boundaries between the type of investors and the type of deals made. 

All of a sudden, there's no market segmentation and specialisation seems to be trumped by deep pockets and speed. The market is so twisted that there's a number of people making it a business to get rich off cheap money. Things are clearly not what old timers have lived through and the VC asset class is under a lot of pressure to reinvent itself. If folks won't change their mindset and start thinking strategically, they will soon have no business. 

So where is this going? The market is fragmented as is anyways, particularly in Europe, and like anything cyclical I'd expect a consolidation wave to begin sooner rather than later.

One thing that will happen is that some funds will not be able return their funds and consequently will not be able to raise money any more, and will simply go out of business. 

Another is that we will probably see a market aggregation, with small shops joining forces in order to at least remain in the market. That could also take the form of secondary sales of portions or full portfolios transacted among their managers.

Playing it small and being strong only on a local level, in one geography, is not going to be as profitable since even tier 2 and tier 3 funds set up scout programs active everywhere, you don't even know who's working for who anymore, and who's behind the money invested in a deal. This also puts a bit of pressure on the angel side of the business. 

We will see more specialisations - either very focused on a niche or on a vertical, which will require deeper knowledge and experience than the standard know-it-all two years junior work for McKinsey.

A variation of this is the solo VC, a one-man show, experienced, knowledgable and committed, with low overheads being able to gain trust of founders at later stage levels. The European version of this is the super angels - TaavetMattCharlie etc. Another variation of this is that folks will start selling complementary financial products, with risk hedge wrapped up in other forms i.e. revenue-based. We already have an emergent class of VC-backed incumbents (example), as well as VCs themselves already hedging their bets in this direction (example).

Those are just some ways in which the market can evolve.

Nevertheless, my favourite way of looking at things is that instead of being complacent with a status quo, it's better to craft your own fate by choosing a strategy and sticking with it. And I don't mean the investment strategy but the business strategy, which is particulary different and hard to do.

If you're doing the right thinking and work with the right people, in most cases you're betting on a winning horse. A textbook instance is not doing what other are doing, and build assets at the margins of the business that can become strategic in a long term game - examples include things VCs outsource now and account as opex like digital intel platforms, lead gens, recruiting platforms etc. And of course, you gotta be able to implement it as well, which requires a different type of skills than investing - sometimes it's wiser to buy rather that build in house, so a lateral move of buying a team that does assets at the edge can make more sense. That would be unusual in the European market though but... it'd be doing what others are not, right?

Last, but not least, and actually a credo of mine (recurring theme for regulars of this list) is that when the music will stop and the economic tide will turn in Europe, investors will get back to fundamentals investing as opposed to FOMO. And the best way to do it right is to have at least an active hand as early as possible in the ecosystem, at seed and pre-seed levels.

Europe actually lacks institutional investors backing at pre-seed and seed, with Seedcamp and Speedinvest being the notable players investing across the continent. Another institutional that does pre-seed well, albeit only in Finland and timidly in Sweden and the Baltics, is Icebreaker. Here's what they say about it:

There are several reasons why early stage firms avoid the Pre-seed [...]. The [main] culprits are 1) the incentives created by management fees, 2) the simple fact that Pre-seed and Idea Stage investing is scarier than investing at the Seed or Series A and 3) the fact that most venture firms are not equipped to help companies before they have reached product market fit.

That is a neat summary of the European VC industry flaws at all levels: Translation:  1. un-fit business model, 2. low risk appetite when you're in the business of funding risk and 3. poor professional background for providing business advice.

Are those problems structural or easy to fix? Is the money, as they say, going to solve everything, as now there's a lot of it? Do you have the right people in your team to go through this turbulence? My guess is that we will see it sooner rather later - fact is that it looks more like a serious storm, not a turbulence.



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