The Cambrian explosion in startup financing
The basic premise of punctuated equillibrium1 theory in evolution is that everything muddles along between disruptions (usually some form of disaster) with the consequences of those disruptions (and occasionally the more resilient remnants of the previous era) shaping the next period of evolution. This generally makes sense to people when you mention dinosaurs but it increasingly feels like a useful description for what’s happening in the VC/startup financing ecosystem.
Post the interest-rate shock/tech drawdown/pivot to profitability, there are several emerging categories of behavior amongst both VCs and founders:
Existing VC funds are raising new funds, although with a wide variance of sizes relative to their last. Some are giving up.
Ostensibly inspired by private equity, new funds are being rolled out to buy up VC-backed startups which are trading sideways.
Ostensibly inspired by Constellation Software, new funds are being rolled out to buy up non-venture backed software companies in verticals.
Ostensibly inspired by Tiny (and in turn Berkshire Hathaway2), new funds are being rolled out to buy up basically anything small that has profits with a ‘hold forever’ attitude
Other new funds are being rolled out to be the ‘first and last cheque’ for founders who want to build profitable companies.
Some companies are being divested from their original acquirer or out of bankruptcies 3.
Existing founders have found religion on profitability and are quite actively pushing for this metric as soon as they can (and anyone who isn’t probably won’t see Q3 24). A lot of this is going hand in hand with an anti-VC rhetoric.
New founders are focusing on companies which can be profitable very quickly.
Realising that the VC model is hard but that also building companies is hard, several people (many ex-founders) are rolling out venture studio model combining several aspects of the above.
This is all quite exciting! But what does this Cambrian explosion of financing actually mean? Some half-formed thoughts on a few of these trends:
Sideways acquisition funds
Buying up the non-performing (but importantly non-dying) VC-backed companies makes total sense to everyone involved. However I think the biggest challenge will negotiating with investors who are highly incentivised not to do a deal unless absolutely no alternative remains-this is a truly brutal context for any negotiation. But perhaps billboards will help?
First/last cheque funds
I’ve been in a few conversations with funds who seem to think that first/last cheque models will lead to the same kind of fund outcome as general early stage funds. Maybe? I’m not sure, for a couple of reasons. Firstly, I think this is obvious but it’s perhaps worth stating anyway that building profitable companies is actually quite hard and certainly harder than building loss-making companies. So while it’s an excellent discipline to have and will make for more sustainable companies, I do wonder what it might do to short term failure rates for these first/last cheque funds. I don’t know. Secondly, I’m not sure if investors (and founders) have quite reckoned with public markets having pushed down valuations, by definition this will push down acquiring multiples too. Or at least for now.
Vertical software rollups
A lot of people quote Constellation Software as their architectural reference but it will be interesting to see how much they’re willing to also adopt the same incentive models which has driven a lot of their success.
Venture studios
I don’t know why VCs seem to hate venture studios but it’s weirdly consistent. Anyway, anecdotally it seems like the model is attracting a lot of founders as their strategy for building new companies. I think the successful outcomes here will a) overcome the survivor bias that probably led to the venture studio in the first place and b) not rely on an existing Series A/B VC model for scaling their companies.
I can’t find it right this second but somebody wrote a clever thing on X about VCs just being just wrappers for LPs. While that’s both funny and clever, it’s only partially true. I think that moreso one of the surviving factors from the bull market era is the fungibility of capital in this ecosystem. VCs no longer have a monopoly on investing in startups or perhaps stated in a less contentious way: the traditional investors in VCs are now happier to invest directly into founder-led opportunities, avoiding (some) fees and carry tax.
I think this next evolutionary wave of startup financing will see a distinct class of hybrid operator/financiers emerge. Whether this leads to a handful of Titanosaur-sized conglomerates (comprising many small, profitable companies) or a much larger selection of reptilian-like4 companies, it’s too early in the evolutionary cycle to say.
Generally attributed to Stephen Jay Gould who used it as an evolution model but increasingly is being applied to anthropology too
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I increasingly think the Munger/Buffett model is misunderstood by some of these operators but I suppose if that’s the price of more people thinking about sustainability then it isn’t the worst thing
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Which, if you ignore how they got there, kind of look like the same thing.
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Meaning resilient and adaptable rather than fomenting a global conspiracy
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