A few weeks back, I read a post on Mark Suster’s Blog Both Sides of the Table called “The Changing Structure of the VC Industry”. It evoked a very strong response in me and I have been struggling since then to put my thoughts on his post on paper.
Put simply, I agree with many of his conclusions. The piece is one of the most thought-out, best researched pieces I have seen on Venture investing in some time (including this one). His basic premise is that even though everyone bemoans the decline in venture investing, the numbers actually paint a different picture. Professional Venture investors are not being overrun by Angels, nor is there a wholesale decline in the number of VCs out there. Instead, he argues, the boundaries are blurring (my word) between investment stages. Large VCs are increasing their late stage investing. Many old shops are closing down, but their numbers are being more than offset by new funds emerging. This is almost a changing of the guard as we transition from Web 1.0 successes and failures to Web 2.0’s new crop of hits.
Suster seems to draw two conclusions from his data. First, that the VC industry is undergoing transition but remains fundamentally healthy. He makes a very good case for this, and I agree with it. However, he closes his piece with the idea that the public funds who have been dabbling in VC (mutual and hedge funds) will eventually exit the market and go back to doing what they do best, namely trading public stocks. Admittedly, this is a side argument for his piece, but it got me thinking.
He argues that the traditional divisions among VC funds is blurring with the staging of funds changing as their sizes grow. It occurred to me that the public funds are no different. We hear similar comments from time to time in the public fund universe as well.
I think this blurring will continue, and we will see a steady shift to a new structure for the whole capital raising industry.
The distinction between and a public and a private company is entirely arbitrary. It is an artifact of habit and adaptation to regulation, but there is no ‘natural’ reason to draw the line where we do. Set aside the regulatory regime for a moment. Instead of thinking about public versus private, we should view companies on a spectrum, with companies changing their capital structure as the number of investors grow. As the company grows, it will need to attract more capital and that will mean more investors. This in turn will dictate more mature corporate structures.
Today, there is so much focus on the IPO and getting ready to go public. I argue elsewhere (constantly) that there is too much of a disconnect between the way that private companies prepare for their IPO and what their life is like once they are public. If we were starting from scratch today, we would have a more gradual transition. Each step in the fund-raising process should be preparing companies for being more mature. Instead, of slowly aging, the system today treats companies like they are caterpillars that enter a cocoon and emerge at IPO as a butterfly (or ugly moth). As if these were two wholly different stages of life.
I think the changes in the venture industry will be mirrored in the public markets as well. I think more mutual funds will enter late-stage private financing rounds. As Suster (and others) note, the returns in growth investing are increasingly going to private investors. So it makes sense that the money managers of the world will follow Sutton’s Law and go where the money is.
Obviously, we are not there yet, but you can see the pieces starting to fall into place. The crowdfunding ‘movement’ is likely to grow, and seems set to provide the regulatory bridge between public and private investors.
This will be a change not only for venture investors, but for the whole financing business.