The new era of Venture Capital
The party’s over, some might say. Perhaps it wasn’t a party, perhaps it was an illusion.
With interest rates practically zero or negative following the great financial crisis, success stories of then-recent startups, and an unprecedented promotion of entrepreneurship in Spain and Europe, the Venture Capital industry experienced enormous growth over the past decade. And enormous growth often implies a lack of rigor.
Venture Capital typically focuses on investing in the early stages of innovative/tech companies (startups), with a high-risk component (many startups fail, and the more disruptive and younger the company, worse they fail) and another of high returns (investing early in companies that can grow very quickly, with valuations far below what they could reach in the medium term).
Venture Capital is sexy. Especially with the returns and multiples on investment that the most notable cases show in the media. And in a short time. However, the media rarely talks about the thousands of startups that fail while trying. Nor about the managers who raised hundreds of millions of euros for Venture Capital funds in emerging ecosystems. Hundreds of millions? For early-stage startups? Yes, or for whatever, others might say. For the party.
Although not everything that glitters is gold, Venture Capital has shone in the past decade more than ever. Due to the attractiveness of its success stories, with very attractive returns obtained by helping entrepreneurs “achieve their dreams.” Due to a lack of alternatives. So as not to miss out on the party. And more guests arrived than expected: from inexperienced Business Angels to corporations with no real interest in returns on their investment, to funds (of all kinds, not just Venture Capital), Family Offices, banks, and a long etcetera. All of this seasoned with a wide range of regional, national, and supranational subsidies to promote entrepreneurship.
Possibly too much money for a market segment that should be niche. Let’s remember: Startups = strong innovation/technology + early stage. This should imply few truly new startups each year (compared to cafés, for example) and little investment volume required by them (to minimize dilution while achieving milestones that reduce their risk, such as reaching profitability!). When I talk about “real” startups, I mean that a café that allows you to book a table online is not a startup. And when I talk about a small investment volume required, I mean that to achieve high returns, you have to invest early and at moderate valuations, a point at which startups cannot digest tens of millions of euros. They neither deserve those valuations, nor would they know what to do with so much money. But it was there, and many decided to take it.
The illusion already began in 2017-2019. With nonsensical valuations of tens of millions in startups with barely any revenue. With many eager to burn cash as if there was no tomorrow, most often encouraged by their investors. The next funding round will come, they said. With unicorns (startups reaching a billion in valuation) losing hundreds of millions of euros a year. More like donkeys with cones than unicorns, as a close co-investor would say. With mega-investors putting in hundreds of millions without looking at numbers or valuations (see the case of Softbank in Wework, for example). With the infinite dependency on external financing, like a game resembling musical chairs: you don’t fund a company until it grows and becomes profitable, but until the next investor comes along, buys your stake, and continues funding the startup. Until there was no next investor, and many realized that many of their invested startups were not sustainable and were never going to be profitable. Had it all been an illusion?
The music stopped in the second half of 2022. Inflation, rising interest rates, geopolitical tensions, the emergence of alternative investments… and the loss of Venture Capital’s shine. Yes, it’s true that specialist and rigorous funds had achieved very good returns, but others did not. And particularly many of those with the highest pedigrees, which had allowed them to raise a lot of money, and the more money you manage, the harder it is to make it profitable in a small market segment, as mentioned. There is a great disparity between managers, and clearly, not everything that glitters is gold. Moreover, many of the “tourists” disappeared, causing a deafening silence for startups accustomed to easy money and enormous bargaining power with investors.
All of this leads us to a new era for Venture Capital. One in which we must bring order thanks to what we have learned in the last decade. In which rigorous managers will flourish, and true startups will ask for the money they think they need, not the maximum they can raise at the highest possible valuation. And we see it: treasury management is back, the search for profitability and margins, at the unit and company level. Moderate valuations and favourable conditions for specialist investors are back. The creation of companies and value for customers, employees, and shareholders… as opposed to maximizing personal enrichment in the shortest possible time, for entrepreneurs or managers.
Venture Capital should be understood as a long-term investment. Experienced managers’ funds last 8-10 years, spanning several cycles. With great advantages due to their lack of correlation with other assets and their high expected returns (good managers exceed an IRR of 15-20%). With significant externalities for our society by promoting innovation and business competitiveness. But always with a long-term business vision, with ambition to maximize the value created, with rigor in valuations, business management, and portfolio management. Thus, at the crossroads of adopting highly disruptive technologies and returning to reason in valuations and business management, the new era of Venture Capital seems to be overcoming the illusion of recent years. Only with order and ethics will we be able to consolidate investment in innovation, entrepreneurship, and technology in our country, so important for our future. Venture Capital has never been a party. It is a profession that requires discipline and rigor.
Sources in media: Funds People (Spanish only!)
