Innovations in the Venture Capital Industry

Somebody bring me back some money please, hey

I got a million ways to get it, choose one

Hey, bring it back, bring it back

Now double your money and make a stack

I'm on to the next one.

- Jay-Z

I don't know a lot of about the nitty gritty of the Venture Capital industry but I presume that a majority of the decisions are made around optimizing returns for limited partners like large banks and pensions. This is appropriate - it's called a fiduciary duty - because these institutions have to manage the deposits of the customers and have fixed timelines of when they need to have the cash returned, depending on their balance sheets.

Unfortunately, this mechanizes behavior incentives to make investments in companies that would make a lot of money but don't really doing anything because they can easily attract and retain users (Twitter, for example). Because most venture capital funds have a hard deadline of returning the funds within 10 years, a firm must be VERY focussed in its ability to make good investments. Most firms specialize (appropriately) in a particular stage of company growth (seed stage vs late stage) and do not deviate. This forces them to pass up opportunities that are objectively good ones but don't fit into their investment strategy because they have to answer to their LPs and worry about having a good track record so that they can easily raise money for a new fund.

But there are some people innovating in this area:

Union Square Ventures just announced that they raised a new Opportunity Fund to keep capital in reserve for investments that are good opportunities but don't fit within their investment strategy.

Additionally, Andreesen-Horowitz announced a few weeks ago that they raised an astronomical $650M for an all-stage fund. Ben Horowitz, GP for the fund stated on his blog the reason for this:

"As a matter of core philosophy, we invest in companies, not stages. We want to be in business with the best entrepreneurs going after the biggest markets and we do not care whether they need seed money, venture money or growth money. We believe in great entrepreneurs and the products and companies they build. We do not focus on special return profiles for various stages of investment. As a result, our fund is stage agnostic... we are excited about investing $50,000 in new seed deals and we are excited about investing $50,000,000 in companies like Skype."

Specifically with the new Union Square Ventures Opportunity Fund, it is an interesting fund model: non-commitment of the entire fund, pay-for-play fees only on the money that's invested and a loosely defined investment strategy (opportunistic).

It might be interesting to align LPs, VCs, and the ever growing demand/need from entrepeneurs and early-stage companies to have on-demand investment as they pivot their direction towards reaching market validation AND be poised to make an investment to ride the upside once (if) the companies get on rails.

Of course, it's easy to talk about. Much harder to raise. Even harder to manage. USV and Andreesen-Horowitz are rock stars with great track records in building companies and good investment decisions - they have the clout to convince people that they can pull this stuff off. It will be interesting to see if the rest of the industry follows suit and tries to convince the LP community to engage in this type of risk profile in an attempt to align investment incentives with the reality of the entrepreneur.

Simply put: it seems like institutional investment is like traditional education in that they both understand that learning and growth is non-linear but seem to invest and teach in batches (investment round, classes of students) as if it was linear. *Why* we invest in rounds is something that I know nothing about (hopefully someone can tell me). Maybe because on opportunistic investment strategy provides less certainty for GPs as well as LPs and humans naturally opt for structure and the "known" even it is not optimal (ex: investing in bonds vs stocks).

One thing that might be interesting to examine is the relationship between firm performance (revenue/profit growth, probability of an exit, value at exit) and how close to on-demand investment the company receives (smaller round size, frequency of rounds and frequency and size of bridge loans in between rounds).

We have schools of thought around running lean: just-in-time inventory management, on-demand production and lean startup strategy. Why don't we have lean investment?

Maybe it's possible only in certain industries (both the firms mentioned here invest in hi-tech companies). Maybe it's possible only in certain investment stages. Maybe it's not possible at all or it's so hard that it might as well be considered impossible. But it seems like the logical move for the at least part of the industry and I imagine that we'll be seeing some retooling with the business model in the medium term.

Now I'm just a kid and I don't talk to investors and I don't have the professional experience or track record as these guys. So I wouldn't say that I'm the first to ask this question but I think it's an interesting possibility to drill down on and then build up from.

The question for me personally is whether or not anyone could do this. Could anyone follow the template model that Union Square is leading with to build regional micro-VCs? Could I help contribute to this? Anyone else interested in this?