5 Trends Transforming the World of Venture Capital
As a designer with no formal business training, I could be the last person qualified to write about the world of venture capital. However, over the last several years of working with dozens of startups seeking seed funding, and scale-ups pitching for Series A, I’ve taken it upon myself to learn the language. To learn more about investing, I highly recommend Neil Murray’s newsletter, Series F. But for those startups trying to get a handle on macro-level trends in the world of VC, I am going to share how I see it from an outsider’s perspective.
One helpful piece of context is that my VC education is driven largely by witnessing first-hand how these firms work in the Midwest, contrasting with what I read from the SF-area firms. As with most things tech, Silicon Valley is the most mature market and often provides a glimpse of the future for other emerging markets. It’s also true that emerging markets can learn from the missteps of those pioneers and chart different paths.
I’ve been following a few trends in venture capital that I think are exciting and possibly transformative. They are:
- Theme Investing
“Zebra” is a term created to contrast the unicorn, which has typically referred to companies valued at $1 billion or more. Zebras represent companies that are profitable, sustainable, and beneficial to society. As I’ve been digging into this trend, I can see the need to insert a new metaphor in the startup world.
Unicorns are being chased at all costs, and it’s had a negative effect on entrepreneurs. What may start as an idealistic passion to change the world can easily get bastardized into chasing user acquisition, monthly recurring revenue (MRR), and hockey stick growth…at any cost.
At the heart of this is the notion that VC firms are chasing 10x returns. I’m no financial analyst, but that seems a bit like overkill. You might want to be Lebron, but if you could settle with playing in the NBA, you’d probably be just as happy.
And that’s what is really behind the Zebra trend: a reality check that every startup doesn’t need to be a unicorn. Indie.vc proves this with a long list of companies they fund, and other companies that have scaled based on revenue rather than funding (also note how simple their own website is: the zebra mentality is carried through top to bottom).
It’s not that becoming a unicorn is inherently bad, but the mentality to get there can create a series of bad decisions that lead to failed products like the Juicero—a SaaS-based juice startup—when simply making a better juicer would’ve been sufficient.
What it means for the Midwest
The Zebra trend is particularly relatable to Midwest tech hubs that are trying to evolve older industries like agriculture and manufacturing. Creating unicorns is less attractive than creating strong companies with the goal of establishing a healthy local economy. Pumping startups with cash in hopes of a 10x return may be fun in the short-term, but it doesn’t provide long-term stability and healthy growth.
St. Louis recently announced a locally-focused fund called “Spirit of St. Louis.” Dustin McKissen makes a great point:
Identifying the connection between entrepreneurship and job connection is relatively rare. More often the emphasis is on disruption, innovation, and creating billion-dollar “unicorns.”
Ultimately, tech products should solve problems, but businesses should help local economies. Nowhere is this more pronounced than the Rust Belt. Here, it’s less important to roll the dice on unicorns and more important to establish strong companies that strengthen local economies. As the Rust Belt continues to emerge as a key player in the tech industry, this trend will become the norm.
Takeaways for startups
Focus on jobs over profits – Maybe it’s just the Heartland in me, but I tend to believe that while tech companies can service customers around the world, they can still have a local impact. The Fortune 500 is full of companies that grew slowly, created long-term value for investors, and provided amazing places to work. Tech doesn’t need to be different. SaaS products can still grow by focusing on employees as much as they do their profits.
Set realistic revenue targets – The path to healthy growth starts with realistic targets. Given enough time and creativity, every startup can plot a path to unicorn-land, and often VC’s may feel the same way. But setting realistic expectations early on will lead to better product decisions down the road. Ultimately, you may find that early on you might have more revenue-based growth opportunity than you realize and wait to take on more investment (if at all).
Sexism and lack of diversity are in the news, and the tech industry has an acknowledged problem. VC firms are in a unique position to help create sea changes through the way they staff their own teams, and the way they seek out investment opportunities in historically overlooked pockets of the white-male dominated tech industry.
VC firms like The Catalyst Fund are committed to backing minority-run startups, but so are older firms like Flybridge Partners. They created X Factor Ventures, a sub-group aimed solely at investing in female-led startups. And extending the idea of diversity outside of the U.S., some firms are starting to focus investments on immigrant-led companies (Unshackled VC is a great example).
The issue of diversity in tech is, without question, one of the biggest challenges facing the industry. It has to be addressed at every level, from every angle. But with the recent spate of negative stories, it is heartening to see a growing current of intentional effort to change the status quo.
Takeaways for startups
Include diversity as a core tenet from the beginning. This will matter more to investors not only as a criteria for investing, but also because it shows them your company will be stronger and more innovative. The numbers about the positive impacts of diversity don’t lie, and in a market that rewards innovation, your own product teams need diverse perspectives as well.
Reach out to diversity- or female-focused networks. Your network will often mirror who you are as a person, which means you need to be intentional about expanding your network in new directions. In Indianapolis, the number of women and minority-focused tech meetups, groups, and events like the Disrupt Conference grows every month. This is happening in communities nationwide and makes it easier for people to reach outside their own network.
Seek input and feedback outside your friends and family. The friends and family round of funding and early users is a great way to get off the ground. But it’s not exactly the best way to get critical feedback (btw, if you’re wanting tips on socializing an idea, this is a great post). Including diversity in your startup strategy is not just about diversity in people, but diversity in opinions. Investors will have tough questions coming from different perspectives and getting honest feedback will help craft a more solid story.
I won’t pretend to be an expert on crypto-currency. Up until recently I thought Bitcoin was just a piece of an actual coin. I’ve since made it a mission to learn enough to explain it to my mother, but I’m far from being an expert in this specialized space. I’ve concluded that crypto-currency is close to moving past the early adopter phase of the Innovation S-Curve, and there are plenty of VC Firms starting to leverage it.
The Initial Coin Offering (ICO) has begun to threaten the very existence of VC firms—or at least promises to change the way they raise funds. ICOs allow startups to effectively raise their own funds (not too dissimilar from crowd-funding) but in a way that allows them to bypass the regulatory world of traditional VC financing.
What this means to traditional VC’s isn’t quite clear, but the scale and speed of crypto-based fundraising is undeniable. Tezos just closed $232 million dollars worth of bitcoin and ethereum and much of that was within 24 hours. Not to be outdone, Filecoin broke that record by raising $257 million in ICO funding.
It’s easy to see that this is a tough reality for VC’s. But there are a few firms diving in head first. Pantera Capital recently discussed how they are operating in this new space by creating a $100 million dollar bitcoin-based fund. Flybridge also has a portfolio company raising an ICO in September, called Enigma.
It’s still too early to know how this trend will shake out but it’s worth watching the experiments taking place.
Takeaways for startups
Explore more non-traditional funding models. For startups, there have never been more paths for funding and crypto is one of the most unique around. Within cryptocurrency, there are Kickstarter models, and there are an increasing number of VC firms that are playing a role.
Get immersed in the literature around blockchain. A related area to explore is the blockchain itself. It often gets conflated with crypto-currency, but it’s actually the technology behind it (which allows for many new applications). The field is evolving at a break-neck pace so it helps to understand how applications and products are being developed. Cex.io covers blockchain startups, and Azeem Azhar’s fabulous newsletter, Exponential View, collects articles in this realm on a weekly basis.
The design field is in its golden age in tech where its not only being considered a key role for early-stage startups, but mature companies are beginning to understand how it’s a competitive advantage. Venture capital firms are no exception. They are evolving from simply being expert “company pickers” to actually having a hand in making strong companies. It makes sense.
If you’re betting on horses, why not pay for the best horse trainers?
In this case, the horse trainers are designers and product marketers. VC firms are adding this competency in-house as simply another field of expertise they can provide their portfolio companies. There are two key reasons for this evolution. First, consumer standards for well-designed products are higher every year. One of San Francisco’s strongest VC firms, Kleiner Perkins Caufield & Byers, recognized this years ago. In 2012, they started a design fellows program to match designers with their portfolio companies. Most recently, in 2015 they hired an industry guru, John Maeda to head up their design group (he has since left).
The second reason design and marketing are being integrated with VC firms is to handle the inevitable pivot that comes as startups settle in on product market fit. Some of tech’s greatest success stories are those that made a successful pivot. Instagram started out as a location-based app called Burbn. Once they realized their users only really used the photo (and filters) feature, they pivoted. Thankfully, they had strong designers in the company to help them rebrand and re-launch. The reality for VC firms is that the company they invest in isn’t always the one that makes good on their investment. Design and product marketing helps increase the odds a startup can handle the pivot. The Indianapolis venture studio firm, High Alpha, integrated design and marketing services (amongst others) as a core value for their portfolio companies.
By adding product experience to their expertise, VC firms add a key competency to their advisory services, while providing expert guidance to their companies as they evolve.
Note: For VC firms, the need for design rigor is well understood. But not every firm is equipped to staff in-house design and product management knowledge. Wise VC firms consider partnerships with firms that fill their own knowledge gaps in the product world. This can take the form of actually becoming an in-house product agency, a key partner, or simply respected advisors to call on when evaluating new investment opportunities.
Takeaways for startups
Start asking for more design and marketing guidance from a VC firm. In today’s market (SaaS in particular), you need not only strong technology to succeed, but you also need fantastic sales rigor, marketing, design, and brand support. It is a challenge to staff all these roles from the outset and VC firms with a product focus can help. VC firms often provide many business, financial, and HR guidance. Today, you can start to expect design and marketing to be added to that list.
Understand where design and innovation roles fit in your organizational hiring plan. You cannot rely on outside help forever. VC firms will want to see plans for how you plan to grow your own design, marketing, and brand teams just as they have historically expected to see org charts in development and sales.
5. Theme Investing
The concept of focusing on investing in particular fields is by no means new, but it continues to expand and diversify as tech becomes more pervasive in every industry in the galaxy (including the galaxy itself). Theme investing (also called vertical investing) takes two forms:
- Passion and mission-oriented investing
- Industry-specific investing
Investing in a higher purpose
Finding the ROI in ventures that have a higher purpose has always been a challenge, but this is starting to change. The Collaborative Fund invests in companies improving cities, the lives of children, and in healthier, more sustainable consumer goods. In a similar vein, Closed Loop Partners invests in sustainable consumer goods and advanced recycling technologies.
Investing in complex industries
The beauty of tech is that it is industry-agnostic. This is great news for the areas between the coasts that have older industries in dire need of innovation. The Yield Club out of St. Louis focuses exclusively on agricultural technology. Rock Health focuses exclusively on RT Education focuses exclusively on startups changing education for the 21st century. VC Firms are utilizing domain knowledge, or approaching regional industries (like agriculture and manufacturing), and crafting very specific investing services around them.
While I believe design and marketing will become key pieces of future VC firms, for industry-oriented firms, other services will have to be core. Lux Capital is geared specifically towards “emerging science and technology ventures at the outermost edges of what is possible.” They have a team of non-traditional roles that serve as advisors (neuroscientists and philosophers to name a few). The Engine (by MIT), offers tools, people, and labs to help. It’s an approach that will not only increase the quality of prospects they talk to but increase the quality of the companies they work with.
Takeaways for Startups
Embrace complex domains. We’ve already established that zebras are the new unicorns. You won’t see 10x returns in beekeeping innovation, but it could save our food supply. That seems like a good tradeoff.
Partner with local government. The government is always a bit slower to adopt new technology, but it’s certainly waking up to this—particularly on the local scale and for regional industries. Indiana recently passed legislation opening up $250 million for venture investing. Many states are ahead of the curve on this and are itching for brilliant ideas.
Don’t shy away from mission or philosophy-driven ideas. The market for these is increasing and investors are more open to new endeavors whose sole focus isn’t just money. An inkling of a world-changing idea can be amplified with the right investor.
When you look at what’s behind these trends in the tech industry, the trends in the primary sources of funding will obviously change. Tech will become ubiquitous, diversity will continue to increase, valuation will continue to grow beyond dollars and cents (and bitcoins), and companies will continue become more agile, lean, and adaptive. VC firms are following these trends in some cases, and leading the trends in others. It’ll be exciting to see where these trends lead the tech industry next.