Venture Capital Disrupts Itself – New Data on the Asset Class

Investment advisor Cambridge Associates just published a report entitled Venture Capital Disrupts Itself which has some fascinating VC performance data in it. Cambridge makes money by advising large funds such as pension funds and endowments on asset allocation strategies. This includes their alternatives strategy, of which venture capital is one small part. Given Cambridge have one of the largest datasets on underlying venture capital performance globally, this is an important piece of research for the asset class.

Let’s take a step back into history and learn how the majority of the best US funds marketed their firm to their investors for the past ~20 years (excluding the bubble period). In the venture industry, there is a belief that about 15-20 companies a year make up the majority of the returns for that cohort. Paul Kedrosky published a report with the Kauffman Foundation entitled, The Constant: Companies that Matter that analysed the number of companies in the US that get to $100m in revenue by location and sector – the underlying hypothesis being that if a company is able to get to this level of revenue then depending on their growth and product category, they should be able to command a premium valuation on the public markets or in an acquisition. Having seen several VC fundraising decks, this is one of the main arguments they make on why LP’s should continue to back them, “there are 20 deals a year worth getting into, and we are consistently getting into these deals. You’re either in them or you’re not.”

Because of this belief, it has been incredibly hard for first time VC funds to get raised as investors into these funds want to see how they have a competitive advantage to get into one of these 20 companies every year. It’s certainly true that success breeds success, so the best SV funds are almost always oversubscribed by their existing investors. So the argument that a small number of VC firms invest into a small number of companies a year that make up the bulk of the returns of that cohort makes logical sense.

The Cambridge report demystifies this claim of only 15-20 companies making a difference on VC fund performance and sheds new light on how the VC industry is continuing to evolve – and in new markets like Europe and China, finally mature. What their analysis of the top 100 venture investments as measured by value creation (note this means total gains) per year from 1995 through 2012, shows is:

  • an average of 83 companies each year account for value creation in the top 100 investments for each year;
  • in the post-1999 period, the majority of the value creation in the top 100 each year has been generated by deals outside the top 10 deals;
  • an average of 61 VC firms account for value creation in the top 100 investments in venture capital per year; and
  • the composition of the firms participating in this level of value creation has changed, with new and emerging firms consistently accounting for 40%–70% of the value creation in the top 100 over the past 10 years.

The report goes into a lot more detail on the above stats, but what is so interesting is that the distribution of VC returns have changed dramatically since the bubble period. The majority of returns today in VC now come outside of the top 10 largest companies. So this means a larger number of funds today are investing into a larger number of strong performing companies globally. To the players in our ecosystem this all makes sense. On the demand side (ie founders seeking VC) the costs of starting a company are cheaper, every industry in the world is being digitised, new markets continue to be created, and there is more talent in more cities across the globe from which to build your company. On the supply side (ie VC funds investing capital), VCs are creating more specialist funds to differentiate themselves from the platform and multi-stage funds to try and add more value, VCs are innovating by creating value-added services for startups (networks, HR support, sales advice, PR, etc) and the list goes on.

As a VC based outside of the US its great to see hard data on how much non-US company performance plays into the top 100 deals each year. From 2000-2012, they represented an average of 20% of the total gains in the top 100, compared to an average of just 5% from 1995 to 1999, and they reached as high as 50% of gains in 2010. Note, this also includes gains in other countries like India and China, not just Europe.

On top of this, for the last 10 years, 40-70% of the new gains were made be new or emerging managers. As Cambridge reported:

“This makes sense: emerging managers have shown an increased willingness to capture the greater diversity in investments occurring in the top 100. For example, in the post-1999 period, 25% of the total gains driven by emerging managers in the top 100 have come from ex US investments, versus just 11% for established managers. Emerging managers are also highly likely (though not necessarily more likely than established firms in the top 100) to make their initial investments at the seed- and early-stage.”

For Europe, there were a few new exciting VC firms that closed their first fund in 2015 (Felix and Mosaic) and there are more newer funds coming to market in 2016. For European founders this is powerful – more choice from who to raise capital from and more support at every stage from seed to growth. And for LP’s, its never been a better time to get access to new emerging VC managers. There’s never been a more exciting time to be building a technology company anywhere in the world, and I’m proud to be supporting entrepreneurs from all over Europe to achieve their goals.


Non Silicon Valley IPO’s

As of December, we have had three new software based IPO’s on NASDAQ in the final quarter of 2015. Both Instructure and Mimecast listed in mid-November, and Atlassian went public a few weeks ago. All three have built phenomenal businesses, but what is most interesting to me about these last three listings of 2015 is the fact that none of them are based in Silicon Valley, and both Mimecast and Atlasssian were founded outside of the US where they still keep their HQ’s.

They don’t have much else in common. They are going after completely different markets, with differing strategies, different contract values; I’m sure they each have different cultures and differing styles of leadership. But they have proven you don’t have to be based in Silicon Valley, or even in the US to build a large software company.

I’ve noticed a shift over the last two to three years where companies have ultimately decided to keep their companies HQ’d in their local market rather than take it to Silicon Valley. I’m not talking about companies that left their home market when they were only two or three founders and joined an accelerator in the US or ultimately raised angel money in the US and stayed. These are companies who had reached initial product market fit and a few hundred thousand dollars to a few million in ARR and typically had less than 20-30 employees (think DarkTrace, Scytl, Unity etc). Why is this becoming more common?

I would suggest the following five reasons:

  1. Local talent  is more prevalent today in many cities with people who have tech startup and scale experience (in Europe this includes the established cities London, Berlin, Stockholm, Helsinki and Paris and more emerging cities like Copenhagen, Lisbon, Barcelona and Dublin). Even 5 years ago it was hard to find a world-class product manager in London or Stockholm or a VP Eng who had scaled a 100+ person tech org. Never mind the other critical skills – sales ops, SDR’s, inbound marketers etc. But not today.
  2. Developers are the new kingmakers and are making more decisions on which software to use rather than the old top down model. This has been driven by open source software and more developer tools.
  3. Demand for cloud technologies are no longer constrained to the most innovative companies operating in the US. In fact, we are still at the beginning of this shift. Only the CRM market has moved to being more than 50% based in the cloud vs on premise.
  4. The shift from field sales to inside sales. Companies like Salesforce fine-tuned this model and now many companies operate this playbook with SDR’s, AE’s, Customer Success etc. This enables companies to scale much more rapidly than ever before.
  5. Better tools available for growing your business. The internet and other sales/marketing applications allow for more effective and profitable commercial orgs within startups (inbound marketing, sales ops tools, crm, prospecting tools, etc).

This is just the beginning. In the the market that I know the best – Europe – there are dozens of great software businesses being built quietly by amazing teams. Some of them are about to cross over the $100m revenue threshold in 2016, others are getting close to having $10m bookings years and others have only just hit product market fit but are growing faster than any of the cohorts before them. I can’t wait to see more global software companies being built outside of SV.