“He not busy being born is busy dying.”
– Bob Dylan, “It’s Alright, Ma”
The venture capital world has significantly changed and every venture firm has to change with it.
In my 30 plus year career in venture capital I have never seen a more exhilarating yet challenging time. The amount of capital now entering the venture capital ecosystem is staggering. U.S. venture capital investment is likely to hit $100 billion this year. And although fewer companies are raising money, round sizes are swelling. In the third quarter of this year alone, 39 unicorn companies raised $8 Billion.
The advent of mega-funds, with the Softbank Vision Fund front and center, is having a profound impact on the venture capital industry. Not to take away from the brilliance of Masa-san and his long-term investment views, but we should be concerned about this phenomenon’s unintended consequences for the venture business. Company valuations become unnaturally inflated across all investment stages, financing rounds often grow substantially larger than appropriate, exit timelines stretch past the norms creating greater liquidity event concerns, and a considerable amount of capital falls in the hands of undeserving companies leading to more high-profile failures.
So, what does the experienced, more traditional venture firm do in response?
First, let’s recognize that mega-funds such as Softbank are not really in the same business as most venture capital firms. They more typically invest in companies whose aim is to re-imagine whole industries in ways that require substantial amounts of capital. WeWork is a next generation real estate company, Katerra is a profoundly transformative construction company, and of course Uber has re-imagined personal transportation. These kinds of investments have occurred before in history – if FedEx launched today it would probably raise money from a mega-fund, which accounts for why it had difficulty getting off the ground at a time when funding of this kind was unavailable.
In contrast, the traditional venture capital world is more about fueling new companies that disrupt incumbents with advanced technologies and differentiated solutions. When executed properly, in a series of appropriately sized rounds, this can be very capital efficient. There is a formidable list of such companies that are all public today. Among them, Palo Alto Networks, a company we co-invested in with Sequoia Capital and Greylock, consumed all of $65 million in venture capital while private and is valued at over $19 billion today. Other examples include FireEye, another portfolio company, along with ServiceNow, Splunk, Tableau, Veeva Systems, and most recently Elastic, all with multi-billion market capitalizations today and all who raised $100 million or less before going public.
Yet, different as traditional venture capital may be from the mega-fund investment model, the shadow the mega-fund casts requires a re-examination of our businesses. At our firm, Icon Ventures, after a great deal of soul-searching and analysis, we’ve decided on the following course of action:
Sticking to our knitting – Our firm was founded 15 years ago based upon one core idea. Great companies start with extraordinary entrepreneurs and our investment focus is to specialize in leading Series B and C rounds alongside the most successful early-stage venture firms. In very competitive times such as these, we feel it is particularly important to polish our investment model rather than shifting into new areas or investment stages.
Financing Valuations – Heady as valuations may be in this environment, sitting on the sidelines is not an option. We look at the price we pay for deals in terms of “catch up valuation” and stretch for those that can grow into the valuation within a reasonable amount of time.
Size of Financings – Though an abundance of capital can drive larger rounds, this can be a positive thing at the Series C stage and beyond. If larger amounts of capital are properly deployed, it can further accelerate market adoption resulting in greater company momentum and exit value.
Adjusting our Fund Size – It is fundamental to fund performance to have a fund size that is optimal for returns. Based upon the data we track, over the last few years, our target Series B financings have risen from $20 to $25 million and Series C financings from $30 to over $40 million. Our most recent fund was capitalized at $265 million. With the permission of our LPs we re-opened the fund this past summer, adding $110 million of additional capital to expand it to $375 million, to be properly sized to today’s market opportunity.
Creating more Liquidity – With venture-backed companies staying private longer, LPs today are demanding more liquidity from venture firms. Over the last ten years our firm has had 32 successful liquidity events including 5 IPOs. As proud as we are of what we have achieved it is important for us to consider new liquidity paths. In July of this year we consummated a secondary transaction valued at $100 million for the purchase of two of our earlier funds to create additional liquidity for our limited partners.
These are indeed unusual times in the venture capital world. Venture firms will need to consider their individual plans to adjust. Though we are satisfied with what we have accomplished, we need to be prepared for what is ahead. It took a lot of planning and hard-work to position our firm for the future, to be properly positioned for the environment and to believe we are still… “busy being born”.