There is alot I like about Dave McClure's post on VC industry trends. It captures many of the trends of that are transforming the venture capital industry, particularly the bifurcation of "mega VC" and "micro VC" funds. But I think he's missing one important trend that is happening outside of Silicon Valley.
For those of us who practice the VC craft outside of Silicon Valley, it is clear that the mega VC strategy just doesn't work. VC can't successfully deploy $1 billion unless they are investors in mega hits like Facebook, LinkedIn, Twitter and the like that have the potential to generate > $10 billion exits. Nearly all of the mega hits have been Silicon Valley based. Most of the recent big successful exits outside Silicon Valley (e.g., Buddy Media, Demandware, Endeca, Millenial Media) have been in the $500 million – $1 billion range. If you have a $1 billion fund and need to generate 3x to be successful, that's $3 billion in returns. If you own an average of 15-20% per company, that's $15-20 billion in exits. You can't get there $500 million at a time.
The micro VC strategy also is particularly well-suited for Silicon Valley. The successful micro VCs get into the mega-successes early, and also benefit from the high number of quick flips. Some micro VCs are attempting to make this model work outside Silicon Valley (e.g., Founder Collective, Lerer Ventures, NextView), and are seeing early promise, but the results of that strategy is still too early to call.
What is working outside Silicon Valley is small, focused, lifecycle funds. $150-300 million in size, funds like Union Square (NYC), Foundry (Colorado), Spark (Boston) are among those that have generated the best returns for their LPs this decade. These funds, who are neither mega VCs nor micro VCs. They are in the middle. Outside Silicon Valley, being in the middle can work well because you can get in early with small dollars, like a seed fund does, but get fully behind your winners and own 15-20% for $8-12 million. When the $500 million exit is available, you take it and the fund is small enough that it has a big impact. When you have an opportunity to attempt a mega exit and it is time to raise a mega round of financing, you simply go to the mega fund.
A number of companies in our portfolio have followed this strategy. In our first round of financing, we invested $1 million in Open English, an English language learning platform. Over a few years, we kept investing as the company grew. Once the company achieved real scale, mega fund Insight came in and invested $43 million. Similarly, 10gen was at a very early stage when we and Union Square invested. As the company grew and achieved scale, it came time for a mega round. NEA led a $40 million round last quarter.
At Flybridge, we are trying to execute on that middle strategy outside Silicon Valley – a small, focused fund that will invest early and work hard alongside companies for their full lifecycle to generate solid exits sometimes and, hopefully, one or two mega exits.
So far, this strategy is working for us and others. Whether it works in Silicon Valley, I can't say.
Fantastic article, Jeff’s done a great contrast of “mega VC” vs “micro VC
Good post Jeff. What happens to the rights of small VCs investing 1-2 mn if a mega round, say 45mn follows subsequently by big VCs? It seems no matter what structure and shareholders rights are previously negotiated, the small VCs will be squeezed.
If the round is an up round, the small VCs are protected, but often sit behind the preferences of the larger round. If everything is up and to the right, it’s all good. If there’s any sideways movement or twists and turns, they get wiped out. That’s why folks like Flybridge, USV and Spark are lifecycle investors rather than micro VCs. Whether one strategy generates systematically better returns than another is still up for debate.
Great post Jeff.
I reblogged part of it at fredwilson.vc
I wonder if you can get to the $15-20bn in exits $1bn at a time. it seems like you are betting on being in the one or two deals a fund cycle that get to $10bn. and that seems like a lousy bet no matter where you are located.
Agreed, although arguably in Silicon Valley there have been enough > $2 billion exits to make it work for a few select funds who seem to consistently be in those deals (e.g., Greylock, Accel, Sequoia). And thanks for the tip on disqus – seems to be working quite well.