There was a time in San Francisco when pretty much any wealthy individual could write a check and own a piece of a company or a portfolio of companies through partnering with a venture firm.
But being rich doesn’t get you as far in today’s tech landscape.
More and more venture firms, from Palo Alto to Tokyo, are pouring billions of dollars into mammoth, global growth funds known as “mega-funds” that have invested in startups building the future of work, cars, computing, and even dog-walking. Sequoia Capital told limited partners they would have to make a minimum investment of $250 million to procure a spot in its growth fund.
The rush of capital has produced a number of effects, including inflated startup valuations and increases in the amount of capital competing for access to the buzziest startups in Silicon Valley.
“In the early days of venture, one could have made the argument that because venture capitalists had money and entrepreneurs didn’t, and there were limited choices [with fewer funds], having money itself was competitive advantage,” Ron Bouganim, founder and managing partner of boutique venture firm Govtech Fund, told Business Insider.
“With the oversupply of capital, having money alone is not an advantage. There’s so much money chasing every investment opportunity,” Bouganim said. “How do you differentiate yourself from another investor? Some form of specialization is necessary.”
SC Moatti, a former Facebook executive who raised $13 million for her firm Mighty Capital’s debut fund, put it this way: “Money is money. It’s nothing specific. It’s really hard to say, ‘You should take my money because it’s more green that somebody else’s.'”
The situation has created a shift in venture capital, where small-time investors are rewriting the playbook on how to land deals. Those who don’t have the reputation or financial backing of the most established venture firms on Sand Hill Road are getting smarter, not richer, to compete with the fat funds sprouting up.
Some investors look to specialize by targeting a specific tech sector, which gives them a robust network of connections, domain expertise, and higher quality deal flow, because founders start to seek out those firms that aim to deliver more value for their buck.
Knowledge is more valuable than money
The first half of 2018 saw nearly $58 billion invested into venture-backed startups in the US, which is more than VCs deployed for the full year over six of the past 10 years, according to the National Venture Capital Association. An estimated 300 new funds will close in 2018, which only adds to the opportunities for founders to raise.
In order to compete for spots in hot investment deals, investors are asking themselves why a founder should take their money over someone else’s pile of cash. For some, it’s about who they know.
For others, it’s about their expertise.
Clara Brenner and Julie Lein just raised $22 million for their debut fund to invest in startups solving important challenges for cities. Those companies are a tough sell for venture capitalists, because their products often require a lot of money to launch and they face regulatory hurdles from local authorities who prefer the status quo.
“We gravitate towards businesses operating in highly-regulated or politicized spaces. And we offer our companies a lot of hands-on support around these issues, which they’d be hard-pressed to find elsewhere,” Brenner told Business Insider.
The investors met as graduate students at MIT Sloan School of Management, where they studied the intersection of cities and entrepreneurship. They applied their knowledge of urban innovation as cofounders of an accelerator called Tumml, which made early investments in companies such as Chariot, a private shuttle service that carries commuters where they need to go, and Neighborly, an online investment platform for civic projects.
Brenner and Lein helped shape some key policies inside Chariot, including the decision to hire locally and deploy shuttle buses in neighborhoods that are underserved by public transportation, in order to build goodwill in the community. In 2016, Ford bought Chariot for $65 million, creating a nice payout for Tumml.
The investors are betting that their new firm, Urban Innovation Fund, will attract social-impact companies because of their domain expertise. They already have a track record for success: Chariot is thriving, while its Andreessen Horowitz-backed rival shut down.
The decision to specialize was a no-brainer, according to Brenner.
“Specializing helps you stand out. For an entrepreneur, you are demonstrating passion and expertise for their business, which can make you a real value-add,” Brenner said. “For an LP, you are offering them a portfolio that doesn’t look like anyone else’s, which can help them diversify. And, of course, building a well-considered thesis can make you a stronger, more discerning investor.”
A laser-focused venture firm rises
Many years ago, Ron Bouganim made a similar observation.
As the Canadian entrepreneur crawled through the process of becoming a US citizen, he saw that the government was ripe for innovation. In 2014, he launched a venture capital firm called Govtech Fund to deploy capital into startups that aim to help governments be more responsive, efficient, and better able to serve society.
The firm only makes about four investments a year and is laser-focused on technology that modernizes the internal operations of government. This is not to be confused with civic technology, which supports the public’s interaction with government, and is likely a better fit for Brenner and Lein’s Urban Innovation Fund.
Govtech Fund companies build software tools for government employees that improve how they deliver everything from foster care to law enforcement to food safety. The portfolio ranges from Glimpse, which identifies and evaluates a school district’s “eROI” (education return on investment) for every product, program, or strategy implemented in a classroom, to Sema, which transforms legacy software code maintenance for government software systems.
Matt Van Itallie, CEO of Sema, said he considered many venture capitalists when fundraising for his company.
“Our goal was to partner with a fund that truly understood the govtech market,” Van Itallie said in a press release announcing Govtech’s second fund. “We’re not just backed by the Govtech Fund’s capital, but with the govtech ecosystem they have built.”
Companies that have taken venture dollars from Govtech Fund have relationships with over 20,000 government agencies, and according to Bouganim, the ecosystem adds 10 new agencies every day.
It’s not uncommon for those startups to pitch their government partners on services provided by other companies in Govtech Fund’s portfolio. They share learnings with each other in the firm’s Slack channel and on company offsites. Some entrepreneurs even come to work at Govtech HQ, a 4,000-square-foot office space in San Francisco that was designed for hosting speakers, lunch-and-learn programs, and salons with visiting government workers.
Bouganim said while he doesn’t have the resources of a large, private equity fund with “a hundred staff members that are doing research” as if it had an “in-house consulting shop,” he adds value in other ways with a close-knit portfolio of 19 companies.
“I don’t think venture capital is different from any other business,” Bouganim said, adding that when he advises his startups, he tells them, “‘You need to have a large market opportunity, you need to have a differentiated product, and as you scale that product, you need to have competitive moat. If you don’t build competitive moat, someone else will come along and probably displace you.'”
He went on, “So, when you just look at the basic principles of running a startup, why would that apply any differently in the world of venture capital?”
Investors are more involved than ever
Most venture firms specialize to some extent in order to attract a certain type of company. Investors might choose to focus on a venture stage from pre-seed to growth, a geography, or a sector.
With so much money in venture, some investors say they have to do more than specialize in order to attract tier one startups.
“That’s not how you stand out,” said SC Moatti, the former Facebook executive who launched her own venture firm. “You stand out by the value you bring, not by saying, ‘I do this and not that.’ You stand out by saying, ‘You should take my money because it really has a different color, because we give you access to Products That Count.'”
Mighty Capital invests almost exclusively in product-driven startups and differentiates itself from other growth-stage funds by giving its portfolio companies access to Products That Count, one of the world’s largest networks of product managers. It’s helpful if a founder wants to hire product managers, sell to product managers, or get advice from insiders on building their companies at scale.
Moatti has figured out that social influence is what she brings to the table, beyond writing checks for between $500,000 and $1 million.
Mighty Capital makes mostly growth-stage investments, because Moatti said that’s when the firm adds the most value for companies. The job of a product manager is to match a customer’s problem with a solution in the form of a product. This is known as product-market fit, and it’s an essential goal of growth-stage companies.
Some venture firms are building out programming and services to support the portfolio companies after they’ve invested.
Structure Capital, a young venture firm in San Francisco, invests almost exclusively in sharing economy companies whose goal is to reduce waste. (The firm’s founder, Mike Walsh, seeded the fund with $300,000 worth of Uber stock before the company blew up.)
According to Walsh, the firm’s “special sauce” is a two-day bootcamp for portfolio companies that Structure Capital offers. Entrepreneurs meet with advertising executives and brand strategists to craft their brand, through developing logos, idea videos, taglines, mission statements, and their overall brand strategy. This is especially important for sharing economy companies (think Airbnb and Uber) that rely on customers loving the brand to grow their businesses.
In Silicon Valley, it’s the investors who are trying to impress.
“Almost always, we are the most hands-on investor our portfolio companies have,” said Brenner of her new firm, Urban Innovation Fund. “As a team, we pride ourselves on being useful — with deck prep, fundraising support, or policy-related strategic planning. We take their calls and texts late at night, and we are always repping them to other investors.”
According to Moatti, founders should expect nothing less when there’s so much capital competing for investments.
“Most venture capital firms offer money and a network,” Moatti said. “Well, if you’ve been in the Bay Area for long enough, we all have a little bit of money and a network.”
“The fact that we give access to basically hundreds of thousands of potential hires, or hundreds of thousands of potential customers, that’s really differentiated,” she said.