When I started in venture capital in the late 1990s VCs were regularly lambasted for taking long summer holidays and spending too much time on the golf course. I remember one enterprising journalist judging VCs on the basis of how much their handicaps had gone down. Low handicaps weren’t good!
During this time, cash was scarce and VCs were firmly in control. Most investors thought of their job as picking good companies and making sure governance was strong. Decades later, things couldn’t be more different. After about twenty years of different forms of value-added services in VC, it feels like we are approaching a new plateau, to which everyone aspires and few have achieved.
In this post, I want to look at this new plateau, describe how we got here and offer three reasons why this trend has been gathering steam.
From around 2000, and perhaps coinciding with the need to work harder to win deals as opportunities dried up after the internet bubble burst, individual partners at VC firms began adding ‘helping CEOs win’ to their job descriptions.
The most visible symptom of this trend was VCs writing blogs to show just how value add they were. Fred Wilson, Brad Feld and Mark Suster stand out as the three best examples of individuals who built their careers this way, and Benchmark stands out as the fund which best embodies this approach.
Then from the mid 2000s, value add began moving beyond the partner to the firm as VCs began employing people who’s full time job was helping their portfolio.
They called them ‘Platform Teams’ and the value they add varies between funds. The most common strategies are to provide networking services and content to portfolio leaders so they can be more effective in their jobs.
The output takes the form of events where portfolio execs can meet each other, online communities where they can share knowledge and blog posts and talks from experts to disseminate best practice.
The other most common focus areas for platform teams are to employ talent and PR/marketing experts who give advice to portfolio companies on strategy in these areas and have relationships and discounts with pre-vetted agencies who can deliver the work.
It was perhaps First Round Capital that pioneered the platform VC model, but at this point nearly all the major VCs have platform teams of varying sizes, including KPCB, Accel and Sequoia.
The most recent development that’s emerging is an extension of the Platform VC model that we call Applied Venture. There are two key differences between Platform and Applied VC.
Firstly the value add teams at Applied VCs are much larger allowing them to help portfolio companies with execution as well as advice. The services they provide extend to pretty much everything their portfolio needs that it doesn’t make sense for them to have on payroll, and includes talent, growth, design, data science, and development.
This is what brings us to the second big difference: the cost of Applied Venture is too large to finance from a standard VC management fee.
Different funds finance the cost of these teams with a differing weighting of asking portfolio companies to pay for services, larger than normal management fees, and reduced compensation for partners.
Other than Forward Partners, notable examples of the Applied VC model include Andreessen Horowitz, Google Ventures, OpenView and Project A in Berlin. Our value add team is 10 people rising to 15 (servicing a £60m fund), Project A has 130 people on their value add team, Andreessen Horowitz has around 100, Google Ventures has 25-30, and OpenView has 10.
Sidenote: There are a number of great funds that have strategies that are very close to Applied Venture and arguably should have been included in the list above. First Round Capital and Atomico spring to mind. I excluded them because they still focus more on advising portfolio companies rather than supporting with execution and I wanted to be a purist, but the line between Platform VC and Applied Venture is certainly fuzzy and you could argue it either way.
What’s driving this change?
The next interesting question is why the strategy of VC funds is evolving in this way. I believe there are three reasons:
Capital is a commodity, a truism that the VC industry was largely able to ignore in the early days due to lack of capital in the market and scarcity of information for entrepreneurs. Over the last twenty years both of these features of the startup financing world have changed dramatically flipping the balance of power from investor to entrepreneur.
As a result VCs who didn’t want to only compete on price began looking for ways to differentiate their money from the money of other investors and started deploying the strategies listed above.
Entrepreneurship is becoming more science and less art
As the number of startups has exploded over the last 30-40 years best practices have been developed that can be shared from one early stage company to the next. This trend accelerated through the emergence of VC and operator blogging in the early 2000s.
The emergence of these best practices created an opportunity for VCs to become a channel for these best practices, simultaneously improving their service to entrepreneurs and accelerating value creation at their portfolio companies.
The watershed moment in entrepreneurship becoming more science than art as probably Eric Ries’s publication of The Lean Startup in 2011 (although some would argue for Steve Blank’s Four Steps to the Epiphany in 2005).
In addition to Platform and Applied Venture strategies, the trend towards hiring ex-operators into partner roles at VC firms can be seen in this light.
Value add strategies make partners at VC firms more personally effective
Partners at Applied Venture firms can focus their time and energy where it has the most impact, and they can turn to their value add teams to support the portfolio in all other areas.
When it comes to supporting portfolio companies, for most partners that will be advising on strategy and fundraising, helping keep other directors focused on the right things, and supporting founders at a personal level.
The value add teams should be better placed to advice on areas of more detailed execution, including things like employee recognition frameworks, merits of one marketing channel over another, and the best choice of analytics package.
Partners who don’t have the support of a value add team but still want to add value have to allocate a portion of their precious hours to having sensible high level opinions on these sorts of things and building networks of people who can provide support at the more detailed level.
At Forward Partners we believe that these three reasons are becoming stronger over time. Competition is increasing as more capital flows into the market and transparency improves. Best practices continue to develop apace. All the while the best VCs continue to look for ways to leverage their talents.
That can only mean that VCs will continue to find ways to add more value to their capital and that more and more fund managers will adopt the Applied Venture model.
And what’s holding it back?
There are two reasons why the trend towards Applied Venture isn’t playing out more quickly.
When we ask other VCs whether they would like to employ (more) people to help their portfolio the most common response is that they would love to but their management fee won’t stretch that far.
Moreover, most LPs are wary of larger than average management fees, fearing that the extra money won’t be deployed in a way that improves returns, and in particular that the Partners at the funds will simply use the money to increase their drawings.
The GP-LP structure used by most funds is a brake on innovation here too. Because LPs don’t typically have any ownership of the GP they don’t benefit directly when GPs build value into their management companies. This lack of alignment makes conversations about fund managers investing to build value add capabilities harder than they could be.
It’s hard and requires a different mindset
The second reason is that Applied Venture is difficult to execute on from an operational perspective. As well as being great investors, Applied VCs need to run a high value services business. Moreover, if the VC is high quality, the portfolio companies will be high quality and hence very demanding of the value add team.
Executing well on this opportunity requires building a deep understanding of the support entrepreneurs need, developing a suite of services that match those needs and then hiring and maintaining a team that can deliver those services. The people in that team will have very different needs to investment professionals.
The Applied VCs listed above have tackled these challenges and developed solutions that are making a big difference to the success of our portfolio companies and are starting to show that our approach will generate superior returns for our investors.
Although it is early days, we’re starting to see some positive data for our own portfolio. Our companies are 4x more likely to reach Series A, with a 55% higher valuation, 26% faster and with founder equity 2.3x more valuable than their peers.
The success we’re seeing coupled with the experience at other VC firms and the logic outlined above has convinced us that Applied VC is the logical next step for the venture industry.