Venture Capital Will Only Get BetterJuly 18, 2014
The future will be amazing.
Today is pretty awesome too.
I wrote this post on a supercomputer that fits in my pocket using software less than a year old. You’re reading this on a screen that magically connects you to all the world’s knowledge.
Virtual reality is becoming mainstream. People from countries far and wide cheer on the World Cup together in real time. Innovations like self-driving cars are on the horizon.
So what does that have to do with Artivest?
Well, a key thing about awesomeness is that it must be created…and funded. And that means investors.
The reason so many creations happen is that we have a well-functioning mechanism for startups to get the funds they need. And that mechanism is Venture Capital.
Now, some people have been arguing lately that we are in a “bubble” and that as a result venture capital might not be a great place for future returns.
But to me that sounds silly.
The pace of innovation has clearly ramped up over our lifetimes and continues to accelerate. Just compare how fast “chatting” services (think: WhatsApp, SnapChat, etc.) have materialized and boomed vs. the smartphone cycle vs. the computer cycle. Each new wave comes faster than the last.
And this makes sense. As our tools get better and things get easier to build, of course innovation is going to happen more quickly.
More businesses like Uber will emerge more frequently.
But isn’t VC getting a lot of funding?
Well, kind of. But not exactly.
Sure, if you look at the asset class of venture funds in the U.S., there are more funds available than in the last few years. But we are far from the peaks of the late ’90s and early 2000s.
However, far more importantly than that: Venture is tiny. Minuscule.
Venture is less than 3% of the Nasdaq. It is less than 1% of U.S. Equities. And if we look at global capital markets it is 0.01%. A rounding error.
So what, you might assert. Venture is different, it should be smaller.
Well, the increasing pace of innovation in the world today implies that very many of the firms that comprise the Nasdaq and other stock exchanges will be disrupted and likely won’t exist, or at least they will be a lot smaller, in the future.
Just look at Blackberry. In 2008, it had a market cap of $58Bn. Today it is $5Bn. The smartphone market was dramatically transformed by Apple (a previously venture-backed company), changing things forever.
As Peter Thiel, a leading venture capitalist, once said: “Being long Nasdaq is like being short innovation.”
And while that might be an extreme version of the picture, there is some truth to it.
We can say with certainty that being long VC is being long innovation.
It also seems reasonable to conclude that some significant portion of the companies that are in existence today will be disrupted in the future.
In addition, the pie is expanding: 138 million Americans use smartphones today, for instance, up 19% from 2012. And almost 3 billion people around the world will have access to the internet by the end of 2014.
So whether we believe the Nasdaq will grow by 10% over the next few years and that growth will be driven by new firms or that 10% of firms will be disrupted, it is straightforward to conclude that there could be huge returns on the venture capital being invested today.
But the potential is far larger than that. As Bill Gurley recently surmised in describing the potential for Uber, new market entrants create value where it didn’t exist before. In Uber’s case, potentially tens of billions or more.
Companies like Uber and Airbnb create entirely new business concepts, and as a result they change the way the world works. When they do this, value is created that did not exist before.
It’s hard to imagine a world where we can’t look at our friends’ pictures on Facebook or find out about what just happened on Twitter, but the ability to do that literally didn’t exist less than a decade ago.
The challenge about seeing the potential for the future of venture capital is that it requires a kind of faith.
Fortunately, it isn’t a blind faith per se. As highlighted above, the math of it is compelling and every data point supports the idea that innovation will continue.
But the brutal truth of the matter is that we don’t really know.
Will great companies and innovations that don’t exist today emerge tomorrow to make the world more awesome? Will new markets be created that seem obvious in hindsight?
I think the answers here are clear. But it does take a leap. Once you take the leap, that is just the beginning of the story.
As we’ve written about before, returns in Venture follow a “power law,” whereby the best firms tend to outperform over time. This might seem unintuitive: if there is so much innovation, why can’t everyone win?
The reality is that although there most certainly will be new companies made from scratch over the next few years, it is very hard to tell which ones will succeed.
Changing the world is hard.
Identifying which individuals and groups of people are going to be able to pull it off could be harder.
Successful startups require some combination of great ideas, perfect timing, dogged and persistent execution, team chemistry, good communication skills, financial acumen and discipline…and luck. Thus, being a good venture capitalist means that you are able to evaluate all of these things, and what’s more, you are able to invest in them and help them succeed.
As a result, being a venture capitalist is part future reader and also part networker, consultant, advisor, coach, disciplinarian, and of course investor. That makes the job a hard one to do well.
In many asset classes, the decision to participate at all is the most important one. The way you participate —like which vehicle and manager you choose— matters less. This is part of why passive investing has gained so much traction in recent years.
But VC is a different animal, one where manager quality can make a substantial difference to the outcome. That’s why Artivest takes a curated approach.