January 22, 2020

The fragmentation of venture capital

Venture capital has never been more powerful. But it's also fragmenting.

Nicolas Colin

5 min read

Hide and Seek series. Interplay of human profile and geometric design elements on the subject of perception, design, philosophy and science of nature

Venture capital has never appeared as potent and notable as it is today. Firms are multiplying to fund an ever-growing number of tech startups worldwide. Young graduates in engineering and business are now embracing venture capital as a safe and attractive way to join the tech world: not quite as risky as founding a startup, yet more rewarding and interesting than a dull job in the traditional corporate world.

At the same time, and perhaps for many of the same reasons, we’re also witnessing the fragmentation of venture capital. There used to be a time when it was a clearly identified asset class, providing opportunities for careers that were clearly mapped out. Now the industry appears more diverse and complex than ever.

A key trend is the convergence between finance and operations. Views still differ as to how having operating partners in a venture capital fund can really add value for portfolio companies, but long gone is the time when venture capital was dominated by financiers and ex-consultants. Now venture capital funds feel obliged to accumulate skills in fields as diverse and demanding as HR, product, enterprise sales, public relations and lobbying. Inevitably this leads to changes in the nature of the business, from some investors embracing a hands-on approach as they support their portfolio companies, to others not even waiting for an entrepreneur to step forward, instead launching startups themselves via a startup studio.


Meanwhile, the lines are blurring at the late stage. With the rise of tech companies as an asset class, private equity and stock-market operators are confronted with an unprecedented challenge. Because tech is ruled by the specific feature that is increasing returns to scale, now you need to deploy capital in companies that might have a high net asset value, yet that are still losing money every quarter. The consequence is that investors have to find different ways of making money. All those late-stage players, whether they are private equity firms raising tech-focused funds or hedge funds building up tech-focused strategies on public markets, are learning to play a very different game.

A particular segment of interest is that of software as a service (SaaS). SaaS investors and operators have been pioneering a more quantitative approach to startup building that makes it possible for venture capital funds to be more data-driven in their investment decisions. On these particular segments of the market, venture capitalists no longer feel the need to trust their gut when deciding whether to bet on a particular venture. Now they can look at the numbers (customer acquisition costs (CAC), annual recurring revenue (ARR), lifetime value (LTV), churn etc.) and make reasonable assumptions as to the net present value of their potential target.

Indeed some funds have been seduced by the more quantitative approach and are now investing exclusively in software as a service. That’s because if you focus on this particular segment of the market, you can still enjoy the allure of being a venture capitalist, but in fact you are investing in a narrower asset class that resembles retail more than high-tech — and thus what you do looks more like private equity than venture capital per se. It is no coincidence that software as a service has given birth to giant buyout funds, such as Vista Equity Partners, Thoma Bravo and Constellation Software — funds that are far removed from the traditional world of venture capital and that are yet very interested in what we still call, for lack of a better word, “tech companies”.

Meanwhile, complexity is arising at the early stage. Accelerators are fading away due to the increased maturity of most startup ecosystems. But there’s still a need to fund early-stage entrepreneurs, and this gives rise to experiments — from the now highly successful Y Combinator to the industrialisation of angel investing through AngelList to many other experiments elsewhere in the world, including in the prolific crypto market. A notable trend here is the rise of deep tech, whose financing model more closely resembles biotech than tech startups as we know them — that is, it’s about financing technological assets bound to be acquired by incumbents rather than scaling up standalone companies. 

Finally, and perhaps expectedly, there are those who think that venture capital has fallen victim to an excess of hype and that the financial services industry now needs to rediscover the funding of more traditional businesses. Notable in this space are the rise of new approaches such as Indie.vc, which focuses on businesses with the potential for swift profitability, and large tech platforms such as Stripe and Shopify that are making inroads in financing nascent businesses with a range of tools that resemble traditional lending and commercial paper more than they do venture capital fund.

And so venture capital as an industry is not as straightforward as it once was. Indeed, it’s likely to prove a passing thing, having reached its peak somewhere during the past decade. The industry used to be about making the most of public investment in cutting-edge research and funding blitz-scaling companies to build as much as possible before their flotation. But as recently observed by Alex Danco, Ben Thompson and Matt Clifford, it’s possible that we’re now entering the deployment phase of the new age (to borrow Carlota Perez’s framework of Technological Revolutions and Financial Capital) and that it will entail a radical transformation of how we fund businesses.

The signs are abundant: new entrants coming up with radical ideas about reinventing venture capital; incumbents slowly realising that they need to renounce business as usual and reposition; and limited partners eager to find the radical upgrade that will solve the current problem of asset allocation and boost their returns. As a result, venture capital is not the monolithic industry that it used to be. It’s getting more innovative by the day and for those who embrace it as a career, the opportunities are more numerous than ever.

Nicolas Colin

Nicolas Colin is cofounder of VC firm The Family. He writes a regular column for Sifted