It is misleading to say that Venture Capital firms are in the investment business. In reality, they are in the business of Human Resources.
Successful venture capitalists aren’t necessarily those who find and fund the most innovative ideas, but the ones who know how to spot founders capable of building a company that will eventually be acquired or go public.
VC investments first came into being in the 1960s, when the US government spent more on R&D than the rest of the world. While that fire hose of cash flowed, the first VCs found many winners to bankroll.
Since then, VCs have backed software companies that grew fast and generate large amounts of money.
Since the golden era of the 2000s, the number of VC firms in the US has risen from 946 to 1,328 in 2019, and the amount of capital managed went from US$170 billion to US$444 billion in 2019. The stellar IPOs in the past years have led to US$121 billion in “dry powder” for the VCs in 2019.
However, the talent spotters have now been marked with a unique challenge of channelling this dry powder in the next generation of unicorns. New investments have drastically slowed down. VCs have found fewer and fewer ideas that fit their preferred pattern.
In the past, software companies were attractive to investors because they were disruptive. Disruptive, often by replacing people in industries those software firms come to dominate—for example, travel agents, whose work is now done by flight booking websites.
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The search for deals is now more focused on employment generation, inclusivity, innovation, and cures. And there is a dearth of deal supply in this space.
In hope of scoring that elusive home run again, many VCs have taken a more innovative approach and started their in-house “accelerators”. Traditionally, accelerators help entrepreneurs take their idea and turn them into an investment-worthy business.
A set curriculum, hands-on support, networking opportunity, access to capital, and mentors – make a very attractive proposition for the founders looking for a jump start. This infrastructure was the bedrock for attracting the next wave of unicorns.
Y Combinator is a shining example of this model, with an impressive alumni list of Airbnb, Stripe, Instacart, etc. Y Combinator quickly pivoted to then be an investor (with an offering of US$150,000 in exchange for seven per cent).
The success of Y Combinator is what has motivated many VCs to innovate their business model and introduce an accelerator arm. At present, there are 170 accelerators programmes in the USA, and numbers are expected to grow 10 times, according to Barclays Fintech Accelerator, Rise.
Does this lead to an added challenge of how will each VC-backed accelerator differentiate itself from others? How narrow or broad the focus will have to be to spot the next idea? How robust infrastructure will have to be created to support these startups to reach the next billion-dollar valuation?
The accelerator is a promising path going forward for many VCs. However, there is a need for speed in the market, given the surplus of US$121 billion dry powder in the market. With that in mind, a more suitable approach will be a combination of VC investment, Accelerator, and an Incubator (building companies from scratch).
While the first two are highly publicised and noted models, the last one is less heard of and well-executed only by a few.
One of the most famous incubators across the world is Rocket Internet (RI). Infamous for their copy cat models of successful Western startups in emerging markets. While RI had a good run for several years with marquee exits such as Lazada, Zalora, Jabong, FoodPanda, and Jumia, the lack of innovation is what led to its eventual exit from Southeast Asia. However, RI had identified this issue much earlier and had pivoted to be a hybrid model of VC and incubator, investing in pioneering startups such as Hello Fresh and Hello Delivery while continuing to build companies from scratch.
To the core of the RI model lies the strong fundamental thought of creating one instead of finding the unicorns. And that is what is needed for most VCs to bring that next billion-dollar idea into the being.
With the combined power of the capital, network, and talented investment partners (most with startup experience), accelerator equivalent resources and the possible creation of shared services (of human resource and technology) to be leveraged on– VCs will be positioned strongly to either give birth or find the home run they have been chasing relentlessly, for a while now!
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