When reality changes fundamentally but the terminology has not changed we get things as ridiculous as:
– Seed Rounds on Crowdfunding platforms that look like a Series C of old (e.g Ethereum raising $15m for a code-less concept).
– Something called Pre Seed that people grappled to name and so they come up with “Embryo Fund”. When somebody decides that the Embryo Stage has become too crowded, some bright spark will figure out the process that creates an embryo, but I won’t name that because this is a family blog 🙂
– Incubators being re-named Accelerators because the Incubator name is associated with the Dot Com collapse.
– The “Shovel In Round” that raises more money than an IPO in the past. The big money -Sovereign/Hedge/Mutual Funds – want to get in before your average Jane gets a chance of investing at the IPO stage.
– the IPO that is being run by the CMO not the CFO. The IPO is now a consumer-branding event. Want $100m capital – call a couple of Sovereign/Hedge/Mutual Funds. Heck, call a VC Fund. Want your company name on the front page and your CEO on TV – do an IPO. When everybody ignores advertising online, this is the best marketing you can do.
– The $1 billion valuation round that garners Unicorn headlines is like the IPO of the Dot Com era (in terms of money raised and marketing value). Except this time the risk is on the founders and management because the investor is protected by Preference Shares/Liquidation Rights. However the value of the headlines may make it worthwhile, because that leads to growth and with enough growth the Preference Shares/Liquidation Rights become a rounding error.
– Multiple rounds all led by the same VC Fund with a financial return greater than 90% of the entire VC industry (Sequoia Capital into WhatsApp for $19 billion exit).
– actual early stage funding being done by Founders, Friends, Family & Fools (Fx4) and Personal Incubators (cashed out founders paying developers for a few months).
The reality that has changed;
- Cost to build a digital product has crashed and continues to crash. There is no Moore’s Law type calculation or name for this but it is far more dramatic and disruptive than Moore’s Law. This is a consequence of increasingly powerful open source, APIs, white label licensing and cloud computing. Add fire sale IP acquisition from ventures that run out of cash to this massive reduction in cost to build a Minimum Viable Product.
- The reduced time from launch to massive scale. For products that “catch fire” (through network effects, viral growth, word of mouth buzz) the time to scale has become so short that traditional fund raising models no longer apply. This is a consequence of about 50% of the world’s 7 billion people having mobile phones connected to the Internet. This means that billions of people have new human needs and have a simple “click here” way to meet those needs.
From a risk-adjusted return on capital perspective (the only thing that matters to investors) there is only one venture life-stage event that matters – Product Market Fit (PMF).
The law of supply and demand is one of the very few things that have not changed in a world where everything seems to be changing at a bewildering pace. The only way to make money as an investor is to find a supply/demand imbalance. You have to find a market where the demand for capital is high but the supply of capital is limited.
A couple of years ago there was a great supply/demand imbalance in what at the time was called Growth Equity but which has become another meaningless name as everybody flooded into the same space (VC is really Growth Equity, but so is Hedge/Sovereign/Mutual). It did not take long for massive amounts of capital to flood in because the Fund managers only needed to look at three simple financial metrics – month to month revenue growth, gross margin at the unit economic level and the cash flow break even point. Getting a business to that stage is still really hard. Deciding whether to invest is relatively easy.
Today, the supply/demand imbalance is at the Pre PMF stage. From PMF to Growth might be only 3 months and then capital floods in. Nobody wants to fund PMF risk. Everybody is running from this risk. There is a good reason for this because the failure rate is very high. The answer is simple pooling and diversification and the financial industry is good at doing this. It used to be you needed 10 ventures to get a shot at one that made it big. In this new world and when looking at Pre PMF the ratio maybe more like 100/1 or more. That is the logic of new VC firms such as 500 Startups, Techstars, Y Combinator.
Fintech is slightly different when you look at this from a PMF perspective. Fintech creates a consumer product. I am using consumer as short-hand to cover all users who take an individual action whether they are consumers, or small business owners as opposed to B2B products where you need to convince multiple people in a large company to write a check. Some Fintech ventures may sell through channels by pitching to developers or banks, but in the end something has to resonate with consumers.
To launch a Fintech product to consumers where money changes hands you need things like regulatory approval and 5 nines reliability. Facebook may use Whatsapp for Payments, but only after Facebook has secured the necessary regulatory approval. Launching a Fintech startup without these will ensure that you do NOT achieve PMF. Launching a Fintech startup with these will ensure that it takes a bit longer and costs more money to launch. The Zuckerberg Faceboook story – a few months of coding and then it catches fire – is inspiring but applies to the social media era and is a mirage when it comes to Fintech.
The Pre PMF cost in Fintech is a little more but not a lot more. It is really a question of having the right people on the team. You need the millennial developers, but you also need the veteran bankers and the person who can dress smart to talk to the regulators. There is often a technical fix to a regulatory hurdle and the regulators are more open than they used to be because a good regulatory environment drives job growth and that is fundamentally what the politicians want.
Note: in this first draft, I did not put in a lot of links, you will have to copy paste into search engines to research the parts that don’t make sense to you.
Regarding naming, I avoid using the term Venture Capital or VC as it has become meaningless. I also avoid Private Equity as a name because a lot of the financing is public on crowdfunding and secondary markets. The name I use is Innovation Capital. I have no idea if the name will catch on, I just wanted a name that was not loaded with connotations that got in the way.
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