The usual story and rationale around VC focus and outcomes no longer makes sense (if it ever did). By their own statistics (Cambridge Associates) they’re pretty bad at their job. The power law returns aren’t just applicable to the companies they invest in but to the funds themselves. Mobile atm so I don’t have all the research to hand but up to circa 2011, it is something like 90-95% of funds did not even manage to return the fund to investors. The success of the entire industry came from the same 5-12 firms, who were largely syndicated into the same handful of investments (Yahoo, Google, LinkedIn, etc.). If you were in the breakout success story for that cycle you were a winner.
I’m pretty dubious about the generally accepted wisdom from a group who have a couple of lottery winners among a bunch of losing bets.
That’s all changed in the current cycle. I don’t think that’s because VCs suddenly got better at what they do. I think it’s because the economics of launching a company changed, as did the expectations around traction to raise your first rounds. There are exceptions in some verticals (hardware, med/bio tech, etc) but then vast majority of startups no longer have huge capital outlay just to prove technical viability. They’re not building a fab facility to produce silicon, they’re not trying to iron out how to do that at scale, they’re not dropping $40K for a single SGI server they need to rack. They’re paying very low opex, and depending on access to credits from vendors maybe not even that. For a team with tech capability they need little more than time to actually build the product to actually have something in market. Plug in Stripe or similar and they’re able to prove revenue too.
The net result is VCs are not investing in anywhere near the same level of risk as they were 10-15 years ago. There’s very little investment in a deck full of ideas (you’d need a team with previous track record) and a lot of investment in scaling working products. “Is this technically possible?” risk is largely non-existent. “Can this team build it?”/execution risk is heavily discounted. “Can this scale?” has been reduced to “worst case we can probably throw money at this with a cloud vendor to weather rapid growth”. What’s left is doubling down on sales and marketing.
What’s happened is a period of riches for VCs because founders & teams have leveraged tech advancements to reduce the risk of failure. But the investment industry hasn’t reacted and have instead captured an outsized upside. And I think the 10 year feedback loop for funds probably isn’t helping them to see it (also, what’s the incentive? Why leave money on the table as an investor?).
I see Earnest and similar initiatives as being the competitive response to correct this imbalance. In 10 years you’ll no longer have VC as an expectation to achieve a unicorn (or whatever we’re calling them then) valuation, and whatever investors you have will have an appropriately risk adjusted return.