VCs are becoming more focused

By September 14, 2011Uncategorized

One of the VCs on a panel yesterday here at Techcrunch Disrupt said that “The days of the generalist investment banker or lawyer VC are over.” a statement I couldn’t agree more with.  There are two dimensions to the focus, one we are all familiar with, and one that is perhaps a bit newer.

The familiar one of course is that good VCs need to have a deep understanding of the companies they invest in, and that means focusing (or specialising) in an area.  Consumer internet, adtech, fintech and cleantech are common choices for focus areas right now.  This specialisation makes sense because it is better for the VC and better for the entrepreneur – the VC makes better decisions because she is investing in things she understands (Warren Buffet describes this as investing within your circle of competence) and the entrepreneur gets an investor who is better able to add value post investment.

The new one is that VCs are getting more focused by stage of investment.  On the panel yesterday James Slavet of Greylock said that the number of firms that are investing all the way from early stage to late stage is decreasing – or to put it in the positive, the number of VC funds that is focusing on either late or early stage is increasing. 

One of the big trends within venture capital, particularly within software and internet investing, is that the period of maximum value creation is shifting from the middle of spectrum, the Series A/Series B, to the ends of the spectrum, very early stage and very late stage.  This bifurcation of value creation explains the rise of the micro-VC and later stage funds like DST.  Traditional venture funds have responded with seed programmes (Menlo announced a new one yesterday) and by raising larger funds to invest at multi-billion valuations in companies like Twitter, Zynga, Dropbox etc.

Most VCs find it very hard to manage small and large investments in a single fund, the passions and skill sets required for operating at the different ends of the spectrum are very different and the differing weight of money creates compensation pressures within the partnership. 

Hence we are now seeing specialisation by stage of investment alongside specialisation by industry sector.

There is a write up of the panel on Techcrunch.

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  • Let us see what the first quartile funds do: all of them (apart rare exception) are multi-sectorial, multi-stage and global or at least pan-regional. 

    Those funds do not restrict themselves, in any manner, to access the best possible opportunities of return on investment “whatever the rest”: sector stage geography… first and foremost focused on maximizing the bottom line for their LPs by whichever manner, sector, stage; one focus: maximise profit.1- Sectorial diversificationThe top quartile investment opportunities are relatively rare and to make sure to maximise one’s chance to tap into them, the generalist approach makes sense as demonstrated by the first quartile VCs. In addition the sectorial specialization is often happening within the multi-sectorial team: the e-commerce specialist, the biotech specialist, the cleantech specialist etc. Experience talent and hard work makes some VCs best whether it is in cleantech or mobile or fintech, a business attitude beyond the scope of specialization.

    If you consider that “software” is 33% of deals made and if a VC focuses only on software, as a LP of that VC, I could wonder if what I win on one side (their sectorial specialization expertise network and capacity of value addition in a given vertical) is not excessively lost on the other side (I miss two third of other great investment opportunities).

    2- Stage diversification

    Also the drift from early stage to later stages is a natural evolution of the industry: small investments taking same time than the big ones and returning less – and more cash for the fund means that fewer deals and higher average ticket optimizes the workload and profit with a team of a given size

    This said, I have been surprised to see some investors not sizing (= depriving their LPs of great profits) excellent early stage investment opportunities while going for the big valuation deals which will no doubt return a lot less. In other word, replacing the team/product/market risk by the valuation/terms and conditions risk.

    Certainly the drift towards late stage has been excessive, at least let us hope so for the good sake of at least entrepreneurs but also LPs and VCs themselves.

    3- Geographical diversification

    Concretely, considering your hunting field as Europe instead of a particular region as an investor multiplies your deal flow by a multiple comprised between 5 and 20 depending on your country of origin. Access to more deal flow means more choice, more capacity to be more selective, access to more deals in a given field and optimize the stage aspect with the time to market aspect.

    4- The capacity of value addition

    The strategic and/or operational capacity of value addition of a VC is not only based on sectorial expertise going along with the network in a given line of business. Some skills applied in one sector work also in another sector. An expert in one sector can bring valuable point of view in a different sector baed precisely on thinking from a different angle. In every sector revenues minus cost equal result, investments can generate “good losses” which are despite their bad appearance the best promise for huge future returns.

    The capacity of value addition to multiply the shareholder value can also be functional-dependant about the VC complementing management competences on board in human resources, strategy, sales and marketing, finance. It is about getting genuinely involved and positively influence the direction of the business rather than passively follow one case between twenty, once in a while, missing half of the board meetings (if participating at all). It is also based on synergies, complementarities, constructive contradictory debate, fit, shared values and vision… The VC becoming a part of the team and being there in particular

    In the end I strongly believe the most consistent in time and best returns will kept on being made by multi-sectorial multi-stage and glocal players with multi-cultural specialized hands on teams 🙂

    And I detail my point of view on 🙂

  • Hi David – your comment has made me realise I conflated arguments about specialisation of individual VCs and funds in a single post.
    Separating them out, I half agree with your points. Most VC funds should have a broad sector focus with individuals focused on more narrow areas.
    Stage focus is a little different though because the disciplines for investing early stage are a world apart from the disciplines required to invest later stage and the impacts on funds and carry are also very different, making it challenging to do both in the same fund, from a management perspective. We saw this play out at 3i and Apax, in both those firms the folk making larger investments started putting pressure on the investors cutting smaller cheques to make sure their gross cash returns from each deal could move the needle in the same way as the larger investments. The early stage guys then had to focus too much on making bigger investments in the tiny percentage of startups that it was obvious from the outset had the potential to be really huge. This skewed the risk profile of the early stage deals and performance dropped off. Meanwhile the best early stage investors started to want to work elsewhere.
    I’m also unconvinced that geographical diversion works. I can’t think of a fund that has invested successfully on a global basis with an integrated model (as opposed to a model of loose ties between funds like we have). Opportunistically reaching abroad into hot markets with an under-developed local VC industry is different.

  • Many VCs in London count staff from various countries to better tackle cultural differences when investing abroad; from that perspective it is 10 times better than it used to be. I provide details about this subject that I am keen about on Akka Venture’s website, so I will just provide a few concrete examples here below.
    As a French VC would you, and your LPs, have preferred to be an early stage investor in Deezer or Spotify? In Wengo or Skype? In Dailymotion or Youtube? In Alapage or Amazon? In Sofialys or Admob?… with all due respect for their respective direct and indirect shareholders and founders, there are some serious objections to betting only on national approach.In the US, some West coast VCs were faster to move on Facebook than locallers from Boston. While 40% of US VC investments are concentrated in the Valley, and that many VCs there say that they don’t want to invest further than a few blocks away, who from the Valley got the lucky shot in Facebook? The ones who dared to invest in a Boston based company 6h flight away.The golden question: who deserves the most the money from the LPs for a demonstrated capacity to generate higher returns?And to speak only of distance and time (the one thing that would turn most of investors off), SF-Boston takes longer time than London-Moscow, for example.. 🙂 To conclude on that geographical dimension of the business, Entrepreneurs want to scale global fast and for that need international investors at least in complement. Europe is a small village with massive inefficiencies, and therefore plenty of opportunities, in the way that VC money is invested. In such a narrow environment, objectively what counts the most is the quality of the deal wherever it is. And the real challenge indeed would more be “trans-continental” (paved with failures to scale successfully a sustainable model…). Apologies for long post but good opportunity to share on that topic of mine! 🙂

  • I would think of Europe as a single region, with London as the most important centre. The US is the other main region, with activity that is still nascent in Asia (although generating some big companies due to population size).
    If LPs want access to US startups they should invest in US funds.