Why venture capital should embrace divergence - Credistick

🌈 Abstract

The article discusses the evolution of the venture capital (VC) industry, the divergence between early-stage and late-stage VC firms, and the potential benefits of embracing this divergence to address the issue of liquidity and transparency in the VC asset class.

🙋 Q&A

[01] Venture Capital Divergence

1. What are the key differences between early-stage and late-stage VC firms?

• Early-stage VC firms (Pre-Seed to Series C) are smaller, thesis-driven, and focused on finding outliers. They have a relatively smaller burden in terms of due diligence and transparency.
• Late-stage VC firms (Series C to Exit) are larger, metrics-driven, and source strong performers directly from early-stage firms. They look at proven businesses with high growth potential through a more standardized lens and are more transparent about deployments and LPs.

2. What are the benefits of this bifurcation of the VC asset class?

• It shortens the feedback window for VC performance and disincentivizes pouring capital into hot deals for inflated TVPI.
• It provides a clear delineation for introducing major institutional capital and the enhanced regulatory scrutiny that should imply.
• It creates a more favorable environment for LPs, a more robust fundraising ecosystem less prone to bubbles and crashes, and an approach to enhancing transparency without hampering smaller early-stage firms.

[02] Changing Venture Capital Economics

1. What are the key questions regarding the economics of this change?

• Whether the basic 2/20 fee structure should change, and whether it should be significantly different between early-stage and late-stage VC firms.
• The degree to which a rational market will change venture capital returns, and whether we can expect a more stable growth in value through the life of a company.
• What is different for firms like Lightspeed that may be using a continuation fund to buy their own secondaries.

2. How does the author propose to address these economic questions? The author suggests letting the market experiment and work this out, especially with added transparency and scrutiny on practices. The author has more faith in positive outcomes, even for firms like Lightspeed, as the performance of both units will be under separate scrutiny, and the incentives should still work.

[03] Drivers of Change

1. What has changed in the last two years that makes the proposed bifurcation of VC attractive? The IPO window closed, and the strategy of dumping companies with inflated valuations on public market investors came to an end. This meant a disproportionate amount of value was unlocked at IPO, and VCs didn't necessarily believe in the value of companies on the way there.

2. How does this change impact the appeal of secondaries? In a market with a more rational perspective on value and pricing, transactions can make sense at any point. Secondaries become much more appealing, as the era of outsized returns at IPO is over, and the focus is now on the timeline of returns.