Venture Capital is Hard: The End of an Era

I’ve been practicing venture now for almost 11 years and been in the tech industry for over 26 years now. It’s fascinating how it seems that everyone looks at venture capital as this glamorous industry. And like everything it looks more sexy from the outside than it really is in reality.

And seems so simple and fun. You meet interesting, smart and ambitious founders all the time, look at business models and give them money in return for a piece of the business. You get to be their trusted advisor and help with issues big and small. Encapsulated in a simple formula: finding, picking and helping startup founders.

But the reality is that it is really hard to be great at this. Every single step of this process of finding, picking and helping is damn hard. Few VCs are good at all three of these steps. And in light of the thousands of new VC funds and investors out there, it’s gotten ferociously competitive. There are very few differentiated venture investors these days. And we are seeing a barbell effect of many small new emerging funds on one side and the big brands like Lightspeed, Sequoia, A16Z, NEA on the other side getting bigger. The middle is getting squeezed out.

And the asset class itself is cyclical and very illiquid so unlike stocks you can’t easily sell it until the business goes public or gets acquired. In most cases they just die. Startups are hard and reliant on a confluence of team, market, timing, technology & demographic trends and business model for great success. That and a tremendous amount of luck.

Every year there are only about 25–35 companies that drive all the returns that year. It’s the ultimate outlier business. It’s not even Pareto’s law where 20% of companies drive 80% or returns. Think 1% of companies drive 80% of returns for VC funds. Crazy right?

It’s so hard because there is the pure challenge of building a high growth business, the ability of the founders and team to adapt and grow.

And on top of this it takes on average in the US seed VC fund 12–14 years before big returns show up. It takes a long frigging time for success and returns. It’s highly illiquid despite an emerging secondaries market and big exits happen usually only after 10 years due to the IPO cycle.

This is the ultimate “long term greedy” business. The majority of exits also depend on acquisitions by big companies and unfortunately unlike the last previous cycles, this has been very challenged due to the very anti-business sentiment of regulators in the USA, UK and European Union (of course the EU).

And if you have a relatively small or medium sized fund, you don’t have enough management fees to have a good salary, cover all admin and legal costs or live a lavish lifestyle. VCs are poorer than you think.

This is why so many venture capitalists have been leaving the industry for the last 3 years. The ZIRP era of cheap money is over, fund performances are cratered by mark downs and fundraising from LPs across have gotten incredibly difficult due to the ugly returns so far of the asset class.

I can attest to how hard fundraising has been both as an LP investing in funds and a VC raising a small fund. I’ve gotten my face ripped off and ghosted by way more LPs and folks in this last year than ever before. This seems consistent with what I hear from VC friends who are in the market.

Consequently, the estimates are that 35–40% of VC funds were inactive in 2023 and Sapphire LP fund of Funds expects 15% of VC funds are not going to raise another fund. I believe this number will be way higher, at least 2x of that number.

This business is so hard, takes so much time, energy and effort and the market has changed so much it’s just easier to quit. So I expect a winnowing out of the venture market this year and next.

It brings to mind the term “Missionaries over Mercenaries” which for both VCs & startup founders become even more relevant these days. Only those who have the fire in the stomach and sparkle in the eyes will still be in the business 5 years from now. You gotta love the business. So for any new and old VCs out there, buckle up. It’s gonna get worse before it gets better. So just focus on staying in the game, the next big cycle is just starting.