Venture Capital Doesn't Exist

"People talking without speaking. People hearing without listening."

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This week, I talked to Madeline Renbarger about megafunds. Why? Because this past week, Founder’s Fund raised $6B, Spark raised $3B, and GC is reportedly in talks to raise $10B. Her question struck me as an important one that I’ve found myself responding to more and more lately:

“What does this mean for the future of venture capital?”

And here was my answer: venture capital doesn’t exist. At least, not in the way we all keep talking about it. This catch-all for every private company raising capital. And continuing to pretend that it does exist in that form does a disservice to everyone involved.

Instead, what we all keep calling “venture capital” is a conflation of four different things: (1) seed stage investing, (2) traditional venture, (3) supercharged growth investing, and (4) previously small cap growth tech stocks. But now we’ve got folks with 2-years as PMs + 2 years of business school helping deploy capital into everything from $1B “seed rounds” to “seed→A→B” rounds in a matter of months.

But for those with eyes to see and ears to hear, each of these categories of investing does still exist. You just have to sift through the noise.

The Seeds of Seed Investing

From whaling expeditions to ARDC, Arthur Rock, and the birth of venture capital as an industry, there’s always been the concept of “seed money.” Seeding an entrepreneurial endeavor. The term “seed round” came later, call it ~2005, and has a rich history but it was meant to be a middle ground between “friends and family” angel money and a “proper” Series A. As Bryce Roberts described it:

“We would write small checks that not only validated the ideas and entrepreneurs as ‘fundable’ but we worked closely with them as board members and mentors to answer the questions follow on capital needed answered.”

There was a logical derisking that could occur in a more formalized pattern than just wealthy angels whipping small checks. But as startups have become more legible, the feeling is that the need for that “on ramp” has become superfluous. But this is less a function of truth and more a function of convenience.

Despite the dozens of scout programs and angels and incubators and accelerators and hacker houses and bootcamps, there is still raw untapped potential in the world of the entrepreneurially minded. There are still people with the intellectual horsepower and cultural grit to shape the future, they just lack the familiarity with how to “play the game.” Seed investing can still offer these people a supportive on-ramp.

Seed investing became diluted because it just became “the first formal round.” And that leads to silly things like calling Thinking Machine’s first round a $2B “seed round.” This isn’t seed investing. Seed investing is defined by playing its role as an on-ramp.

Venture Classic

Over the course of my career, I’ve worked at five different venture firms. I did regional seed investing as a scout at Kickstart Fund in Utah, I was a growth investor at TCV, I was a crossover investor at Coatue, I did venture classic at Index Ventures, and now I do product-led venture at Contrary.

Venture classic does still exist. And arguably, it is a niche category with a sizable amount of risk and outsized reward that is closer to what venture capital has always been. What’s more, its not nearly as competitive as you might think. Will Quist at Slow Ventures is probably the prophet of venture classic, so I’ll summarize what I think he would say.

Venture classic is a narrow, principled version of capital allocation that revolves around funding high-risk experiments to test novel hypotheses with the potential of exceptional economics and value creation, typically at early stages where outcomes are highly uncertain and unknowable in advance. Some key criteria on what it is not?

• It is NOT late stage investing (e.g. investing in Stripe at $159B)

• It is NOT growth equity, pouring fuel on a proven fire

• It is NOT buyouts; financial engineering a P&L into a multiple-expanded outcome

• It is NOT “pro” equity investing, akin to the “private capital version of the Russell 2000... a place for the largest players to park capital and get exposure to technology companies, in exchange for solid (if not astronomical) returns.”

When you really focus on some of the criteria of venture capital, you see some hints of it in frontier categories like biotech or new materials science. But giving $500M to an AI lab right out of the gate is a bastardized version of venture capital because it is operating on the assumption that either (1) the outcomes are fairly certain, or (2) the risk of the experiment is capped because there will always be demand for AI labs, just like there is always money in the banana stand.

Close to the spirit of venture capital, but the heart of it is far removed.

The purpose of venture classic is to let founders run experiments against hypotheses that are knowable and testable, but uncertain. Apple, Microsoft, even Google raised dramatically less capital for their “experimentation” phases, leaning on alternative capital for later growth and expansion. The problem with the non-existent cesspool catchall we keep calling venture capital is that is far more defined by consensus than contrarian experimentation.

Supercharged Growth Investing

What most of the capital deployment we have today would fit into is a very odd bucket that feels akin to old-school growth investing, but it is supercharged. The forces conspiring to supercharge this type of growth investing include the volume of capital competing for deals, the capability of AI as an enabling technology, and the financial profiles of the underlying companies.

In the last 90 days, there were 2.2K funding rounds in the US. In that basket, there were rounds like Skild AI raising a $1.4B round, or World Labs raising $1B, or Zipline raising $600M, or ElevenLabs raising $500M, or Etched raising $500M. I would describe all of these as relatively unproven businesses. Most of them have incredible revenue ramps or technological achievements. But they haven’t been hardened by years of operating the way that traditional growth equity would look for. Instead, the underwriting case for those businesses is momentum rather than fundamentals.

That doesn’t mean they’re bad businesses, or even bad growth investments. But the combination of AI and broad technological experimentation becoming very much in vogue, these companies are moving at unprecedented rates. The danger of this kind of “growth investing” is this: what can go up fast can go down just as fast. We saw that in 2021 with the crypto boom. Companies that raised at prices they’ll never make it back to.

The Small Cap Stocks of Yore

In that same basket of 2.2K funding rounds you also have companies like Anthropic raising $30B, or Databricks raising $5B. These companies, 15-20 years ago, would be public right now. Databricks is valued at $134B. There are only 38 other tech companies valued higher than that in the public markets today. Those rounds should be large hedge funds investing into fast-growing tech stocks.

But a combination of being able to access more capital as a private company and the appeal of avoiding the overhead of operating as a public company has enticed a generation of businesses to stay private dramatically longer than they ever would have before. And because the private moniker makes them less accessible, you get a pool of capital deploying into a hodge podge of secondary tenders and over-priced rounds, just to get exposure.

The Sum of the Parts

None of these are signals of good companies or bad companies, or good investments or bad investments. They’re just different. And, most importantly, they are NOT all venture capital. But each of these asset classes does exist in a way that “venture capital” as this cesspool catchall does not, in fact, exist. And, as with most things that exist, there is a strategy.

Small cap stocks are, primarily, a game of capital. If you have enough capital you can often find your way into Databricks’ $5B round, or Stripe’s latest tender. The trick is you have to have a shiz ton of capital. If you do, you can probably get it in if you work hard enough and you’re not a foreign adversary (though, even then, you have a shot).

The danger is in your returns profile. Odds are that, because they’re illiquid, these companies are counterintuitively being priced to the absolute max. Because the price isn’t a function of logical future business fundamentals; they’re a function of access. So you should assume that the returns on those rounds will very likely be quite low, relative to other index opportunities. Especially if you’re paying 3 and 30 or more to get in.

Supercharged growth investing is primarily a game of access. These hot companies are raising capital, usually off of very little traction. But in an age of froth like the one we’re currently living through, people will compete to get access. Better to do it at a couple billion dollar valuation, in case they really take off. If you have access to these high-flying companies, then you can succeed.

The danger is in the adverse selection. If you try and get into the highest flying growth names but struggle with access, you may find yourself investing in names that look like the highest flyers, but don’t have the special sauce. That’s what made the smartest money avoid them, and made room for you to get “access.” But those companies will never make it to the heady “small cap stocks” of today.

Venture classic is a game of finding high-risk, high-reward experiments in uncertainty. If you know that something will work, either because its obvious, or because the bubble will make it work even when it doesn’t work, then it lacks the je ne sais quoi inherent in the uncertain experimentation. Nothing ventured, nothing gained. Today, AI-native software feels consensus. Vertically-integrated hard tech. Stablecoin payments, AI labs, etc. These categories contain commoditized consensus. Will there still be venture-scale returns from some of the companies in these categories? Yes. Are they likely be in consensus-hyped party rounds of $500M+ for a pre-product, pre-revenue company? No. They’ll be found in the weird, odd stuff that most people think you’re stupid for trying. They’ll look like they have no market, no momentum, no downstream capital. Until they do.

The danger is in the value chain of capital. High-risk experiments are often not executed on one-and-done funding rounds. You need to keep raising capital. And when so much of the capital ecosystem is tied up in consensus-seeking, it can mean that a lot of downstream capital is indisposed at the moment. Which could put your big venture classic bet at risk. The solution is a combination of lean operations, finding odd capital partners (true believers who will be rewarded when it works, or handed a venture-scale loss if it doesn’t), and desperately trying to prove key milestones.

Seed investing is a game of people. The idea, candidly, doesn’t really matter very much. Seed investing is about finding exceptional people with exceptional gumption who will run through walls to shape the world around them. You can support these people, you can help round some of their roughest edges, you can help them become more legible to downstream capital. But, ultimately, it is 99.99% about the people.

The danger is picking the wrong people. Because so many capital allocators have become generalists of both sector and stage, they bring their pre-conceived “pattern recognition” to a “people recognition” game. They try and see “the idea” or “the market” or “the execution.” But, as I said, they do not matter. If you try and engage in seed investing as an ideas / market / execution guy, you will fail. If the horse can’t get itself to water, its probably still gonna die even if you lead it there.

The Aggregate

So, in summary, I’ll use the paraphrased, and probably made up words of Billy Beane:

“Guys, you’re still trying to replace venture capital. I told you we can’t do it, and we can’t do it. Now, what we might be able to do is re-create it. Re-create it in the aggregate.”

Venture capital does not exist. Not the way we use it. What does exist is this aggregated pool of private tech capital deployment. And the more we acknowledge those individual parts, the better off everyone will be. And if large capital agglomerators want to deploy capital out of the same fund into all four types of investing, they are more than welcome to try. And some of them will do quite well.

But founders and funders alike would do well to step back and ask themselves, “what game are we playing?“ Because the unfortunate reality is that most of them actually genuinely don’t know.

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