Velocity and Venture Capital: 11

“How’s work going?”

As we emerge from the pandemic, it’s the common casual question that many of us receive when we reconnect with our friends. I find I am struggling to answer it concisely. In my over twenty-five years in the startup and venture capital (VC) industry, I have never seen anything like this moment that we are in. To answer this friendly inquiry in as clear and open a manner as possible, the only word that comes to mind is velocity.

As everyone who took high school physics knows, velocity is the rate of change of an object's position over a period of time as compared to a frame of reference. Entrepreneurs and VCs have a common historical frame of reference: we are all accustomed to moving quickly and dynamically in our collective journey to fund and build innovative, ground-breaking companies. That collective journey has created a series of routines and common practices over the many decades since the first venture capital firm, ARD, invested in Digital Equipment Corporation in 1957.

What's changed in this pandemic is that the velocity of our activity has dramatically increased due to the systemic removal of any modicum of friction that might have existed in "the old days" up until March of 2020.

Startup Fundraising Process: 1957-2020

To get a sense of how this increased velocity is happening in practice, let me deconstruct the typical fundraising process for the last 60 years of venture capital and startups:

• Entrepreneurs set up meetings with VCs and travel to their offices in SF, NYC, and/or Boston (this business is profoundly concentrated, with 85% of total assets under management in the US concentrated in just three states: California, New York, and Massachusettes).
• A week or two later, follow-up meetings take place at the VC offices for broader exposure amongst the partnership and management teams.
• Then, entrepreneurs host investors in their offices to provide the opportunity for a deeper dive into the business and a tangible sense of the culture as well as an opportunity to meet key executives.
• Upon passing further due diligence to everyone's satisfaction, the management team presents to the entire VC firm on Monday during the weekly partners meeting (which always, always happens on Mondays).
• If the investment decision is made, negotiations on deal terms commence, and after some back and forth over a number of days and additional face-to-face meetings, term sheets are issued and signed.
• Lawyers from both sides are retained to negotiate the definitive investment agreements.
• Definitive agreements are signed, the investment is closed and money is wired.

Entrepreneurs would typically meet with 20-30 firms in order to secure 2-3 term sheets and select their chosen partner. This process typically would take 3-6 months end-to-end simply due to the logistics of multiple rounds of meetings, travel, scheduling, and negotiations. Hence, when we are coaching our entrepreneurs regarding "how long should I plan to be fundraising?", 3-6 months is prudent having 6-9 months of cash cushion gives you a little wiggle room.

Startup Fundraising Process: 2020-2021

When covid hit, everyone's world turned upside down and remote. VCs and entrepreneurs have adapted particularly quickly. As a result, today, the fundraising process for an entrepreneur goes as follows:

• Hold twenty to thirty Zoom meetings, each in 30-minute increments, over the course of a handful of days to meet prospective investors.
• For deeper dives, 60 or 90-minute follow-up meetings are scheduled with a broader set of VC partners at the prospective firm along with various members of the management team -- each of whom seamlessly Zooms in for their relevant portion of the meeting.
• Like Flybridge, many VC firms have shifted their model from weekly Monday morning meetings to multiple meetings per week -- after all, with zero travel and infinitely flexible schedules, it's easy to coordinate the entire investment team's calendars and hold more frequent, smaller time slots to meet teams and discuss investment opportunities.
• Deal documents are now completely standardized and simple. For those of us who invest in the early stages, SAFE notes are the "currency of the realm," which means there is very little to negotiate once an investment decision is made except for price and amount.
• Any possible points of friction -- meeting the entire partnership, meeting other members of the management team, negotiating deal elements, forming a full investment syndicate -- have been eliminated or sharply reduced, easily squeezed in during the course of a day full of remote meetings over Zoom.

As a result of this reduced friction, fundraising -- even for large later-stage companies -- takes only a few weeks. Thus, velocity has dramatically -- in many cases, breathtakingly -- increased.

Some Data

Pitchbook recently released their Q1 2021 report, demonstrating the frenetic pace that everyone in the technology and innovation world is experiencing. Investors deployed $69 billion into nearly 4,000 VC-backed companies in Q1, an increase of 93% in capital deployed in just one year. The amount of capital being deployed, never mind the surge of IPOs and SPACs, is simply dizzying. If you take the estimated early-stage deal count in Q1 2021 1,170 and annualize it to 4,680, it represents a 50% increase from 5 years ago.

To see this graphically, look at the chart below (again, using Pitchbook data). I took the annual overall deal value in Q1 and simply annualized it and chart it in comparison to the last 15 years. At a more granular level, the quarterly data shows that the climb in deal value has been dramatic since the pandemic.

A lot has been written about the rise of SPACs, another financial instrument that makes more capital available to entrepreneurs. The chart below shows that the SPAC market raised record capital in just one quarter as compared to previous years. Again, this surge would only be possible with a surge in velocity and the dramatic reduction of deal friction.

As venture capitalist, Everett Randle put it in an insightful blog post about Tiger Global's strategy of high-velocity capital deployment (which is being replicated by many aggressive growth stage investors), "[Tiger and other fast-moving VC firms] have turned the velocity dial to 11."

Implications

There are many obvious upsides to this increase in velocity, but there are many downsides. Forget that VCs and entrepreneurs are working harder than ever (whine away, my friends -- I hear the violin music now). What really concerns me is the sloppiness that results in increased velocity. Faster due diligence, faster decisions, and fewer opportunities to slow down and build authentic, trust-based relationships can be dangerous when there are bumps in the road. The faster your velocity, the bigger an impact those speed bumps make on you and the organization.

Further, the famous "fraud triangle" of opportunity, incentive, and rationalization suggests this surge in velocity could yield both a surge in underlying incentive and opportunity. Fraud in entrepreneurial settings can range from the obviously illegal (see: Theranos and uBiome) to the slightly exaggerated.

When we are all vaccinated and back to meeting face-to-face, this unsustainable velocity will surely slow down. Right? Until then, everyone is operating at "11".