Before discussing the next big thing in venture capital (VC), let us go through what has happened and is happening right now in the international VC industry, then try to anticipate what may happen in the future.
The current international VC scene
Faster exits: In the past three years, we have seen international start-ups having much faster exits. For example:
l BetaWorks had three exits after only three years of starting its fund. In their first three years, it returned its $26m fund and some extra before the fund term ended.
l TwitterFeed acquired by Bitty.
l TweetDeck acquired by Twitter.
l GroupMe acquired by Skype.
l Troika Ventures achieved a 10-times exit within three years. It sold its shares in Evernote to Sequoia Capital. An investment of $4.5m returned $45m.
Active private capital markets: Private capital markets are growing to create new exit opportunities on which Facebook, Twitter, DropBox, Yelp and many other companies are being traded daily. The most famous exchanges are now SecondMarket and SharesPost.
Rise of accelerators: In the past five years, the concept of accelerators has boomed. It all started with Y-Combinator, which wanted to create a special value-added incubator that accelerated the process of taking a company from idea stage to beta version, creating a proof of concept.
This innovation was followed by many others who added more value and focused more on mentorship such as TechStars, 500 Startups, Dream It Ventures, I/O Ventures, Plug & Play and Hub Ventures.
Then we started to see vertical or thematic accelerators such as:
l TechStars Cloud, focused on start-ups in the cloud com-puting and cloud infrastructure field
l FinTech Innovation Lab, focused on start-ups creating new consumer financial services
l StartAppz, focused on start-ups creating innovative mobile applications.
Those are all acting as public accelerators, meaning anyone can apply to get funded and incubated there. However, this stimulated the idea of private accelerators, or so-called labs – a twist to the old idea lab concept, where ideas are generated internally and put on an acceleration mode before they are nurtured or killed.The biggest examples of this is are BetaWorks and N2V Labs.
Changes in the VC model: The accelerator fund model was a revolutionary concept that challenged the traditional VC model. It also proved that start-ups, especially those involving the web and mobiles, need less time and less money to kick off, and sometimes less time and less money to get an acquisition exit, eliminating the role of the growth-stage VCs.
About 8% of TechStars’ start-ups were acquired after low-level series A funding. The majority of those received an average of $500,000 as a second round and were subsequently acquired, for example SocialThing, which received a few thousand from TechStars, then $500,000 from early-stage VCs, before being acquired by AOL.
Big VC firms are now struggling to capture big opportunities early enough to make big returns, so some of them, such as Polaris Ventures, established their own public accelerator-like environment to access smart entrepreneurs from the very beginning.
However, if not acquired but still active, such start-ups usually reach the growth stage, which nowadays requires more funding than ever, for example DropBox, which received a few thousand from Y-Combinator, then $1.2m, then $6m, then $250m from a group of top US growth VCs. So the need for growth-stage VCs is still there, more than ever in later stages.
Revolutionising the VC model
Elevators: The current market has created an opportunity for a new class of VC funds that takes graduates of accelerators and elevates them either to acquisitions or to growth-stage VCs. Such post-acceleration funds can be called elevator funds, business elevators, or simply elevators.
In a semi-accelerator-like environment, Elevators would invest at a standard deal an amount of $500,000 for a standard equity percentage. But unlike accelerators – that have batches and a fixed three-month term – elevators will have no batches and no fixedinvestment term. The $500,000 might be enough to fund the start-up for six to 18 months based on the founders’ choice.
The investment period will be flexible enough to welcome acquisitions or further investment rounds.
Carry options for entrepreneurs: The founders of a start-up usually offer stock options for their key employees to motivate and retain them. In a VC fund, VCs may offer their investees, or entrepreneurs, carry options – a share of profits – to encourage them to share knowledge and lessons learned with others in the same fund.
This will also encourage them to join forces, merge, collaborate or even join each other’s start-ups if one of them fails.
In addition, stock options in start-ups are used to counter the high salaries competition for talent. Employees agree to take a lower salary for a stake in the start-up.
In VC funds, carry options will be used to counter high valuation competition. VCs will not be able to continue competing on valuations for ever, and entrepreneurs might accept lower valuations for a stake in the fund’s returns.
Capture capital – shorter funds with non-liquid returns: In such market dynamics, where investment needs for seed stages are lower than ever, where exponential valuation increments can be reached within shorter periods of time, where acquisitions can be achieved much faster, and where private capital markets can be utilised as a backup for quicker exits, then, fund lifetimes can be much shorter, as short as three years.
Moreover, as opposed to cash returns in traditional funds, where all investments should be exited or liquidated at the end of the fund lifetime, shorter funds can return higher valued equity that will be validated by attracting fur-ther rounds of investment from top-tier VCs.
So successful start-ups will be definedas those that receive further investment or are acquired.
At the end of the fund’s lifetime, the fund’s equity in its successful start-ups will be distributed to the fund’s investors and managers, provided the investors wish to remain shareholders.
If not, then selling the fund’s shares in successful start-ups in secondary capital markets can be used to liquidate the fund returns at the end of the three years in order to create cash returns, but who wants to exit a start-up that has received a big cheque from a top-tier VC firm.
In other words, the fund’s mission will not be achiev-ing big cash returns. It will be capturing good deals, getting you in it early enough and helping to elevate them to the next stage. This might be called capture capital instead of venture capital, and people who work in accelerators and elevators can be called capture capitalists.
Cafe start-ups: In the past, start-ups were germinated in garages. Apple, Google, Amazon and many others started in small garages. Nowadays they start in cafes, which are more comfortable, serve food and beverages, are more fun, and can accommodate founders and their small teams for longer.
Cafes are being used by lean start-ups to reduce the seed investment needed to take them to the next level. Cafes eliminate real estate, furniture and decoration expenses for offices,which can eat a big chunk of the seed investment, especially in the elevation phase. Investments can be effectively utilised in team building, product development and marketing.
So elevators might encourage start-ups to work from cafes in the firstsix to 18 months, until they receive the next round’s big cheque.