The tranformation of venture capital forges a new role for GPs

When Mark Siegel joined Menlo Ventures in the mid-1990s, he was one associate alongside five partners navigating a compact firm amid the gathering venture capital boom.

When Mark Siegel joined Menlo Ventures in the mid-1990s, he was one associate alongside five partners navigating a compact firm amid the gathering venture capital boom.

In those days, an associate could stay on top of 90 percent of all the companies that received funding, said Siegel, who is now a Menlo managing director.

Fast-forward two decades. Menlo has four managing directors, five partners and three associates or principals, with more on the way. These days, a junior member of the investment team can keep up with about 20 percent of companies getting funded.

The venture capital business is “far more complex and there are far more jobs to do,” Siegel said. “I think we all had to take on extra responsibilities.”

This includes “much more management,” he added.

Siegel’s experience during the past two turbulent decades of the business is not an isolated case. In the years since the end of the Web 1.0 boom, firms have dealt with more change than at anytime in the business’ 60-year history. The role of the GP has shifted accordingly, and perhaps irreversibly.

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The image of a lone-wolf generalist has given way to one requiring a mix of specialization, diversification and capitalization. New managerial skills have become necessary in an increasingly institutionalized industry.

Charting the transformation of the asset class is a complicated exercise.

Not only has it seen a substantial influx of capital in recent years, sending valuations shooting skyward, but many traditional firms broadened investment strategies almost unrecognizably, whether overseas or into seed and growth stage deals. Meanwhile, partnerships have become more entrepreneur centric, offering more accommodating deal terms and formal services for recruiting, customer acquisition and business plan development.

Ownership positions, once as high as 70 percent during an age of capital scarcity, now come closer to 50 percent for the investors of a portfolio company at exit, and sometimes under that. Small exits don’t bring the windfall they once did.

Seed investing, itself institutionalized as a major structural transformation, took place in the nuts and bolts of company development. A new class of micro funds came into existence, and with it an ecosystem of accelerators, ramping up company-creation capacity. Underlying this, the costs of starting a business plummeted and the strategies for company building simplified with the lean methodology.

Early stage entrepreneurs once needed a track record to get money. No longer.

When the companies grew up, another change became evident: growth capital became abundant, allowing maturing businesses to remain private longer.

All of this transformed the role of the GP. Many of the business’ cottage-industry roots disappeared during the process, and GPs had to work harder. They had more to do. The change pushed many to specialize in an increasingly complex technology market and to find new ways to prospect for deals, competing as they had to against a new class of micro VC. They also were forced to become more responsive to LPs at a time when a growing universe of funds gave limited partners more choice.

None of this seems ready to reverse. The future is only likely to bring more of the sometimes competing aims of specialization, diversification and capitalization.

Partners of the past hunted their own deals, caught them, performed the necessary diligence, and then joined the board and helped recruit early employees and early customers using their rolodexes. When a potential M&A opportunity came along, they helped negotiate the deal as a board member.

Now the market’s new realities make these days look quaint. Partners still prospect for deals, but the concept of a firm as a collection of independent, self-managing practitioners is fading. The world of startups has become too large to follow alone. Associates scout the landscape, internal teams perform diligence, in-house staff tracks down talent and helps connect portfolio companies to early customers.

New partners in financial, PR, fundraising and growth increase the complexities of running a firm. The new reality of venture is of an institutionalization that earlier generations could hardly imagine.

Perhaps the first of these shifts can be traced to the evolution of formalized services, a practice pioneered by First Round Capital and Andreessen Horowitz in the middle of the last decade.

“That really was to me the first big disruption in the venture business,” said Jim Marshall, head of the emerging manager practice at Silicon Valley Bank. “People realized venture is a services business.”

What it did was begin to shift the zeitgeist of the industry to be more accommodating to entrepreneurs. And it came at a time when capital was beginning to return to the asset class. VCs who once held the negotiating power saw that power slip to entrepreneurs, who had more choice.

Venture
Mendelson

The result was “VCs had to become more customer focused,” said long-time investor Jason Mendelson, a partner at the Foundry Group.

With today’s constellation of seed investors, micro VCs and pre-seed funds, founders have more places to go for capital. Firms had to develop a personal touch and become service businesses, he said.

One obvious consequence is, “you work harder now than you used to,” Mendelson said. The proof is simple. How many VCs take August off anymore?

The same customer-centric shift applies to LPs, Mendelson noted. Two decades ago, LPs had fewer funds to choose among and GPs didn’t feel the need to invest time in the relationship. Now they understand the need to be more responsive.

General partners realize “we’re in it together,” and conversations no longer take place just once or twice a year, but every month or even daily, if a co-investment with an LP is in the works, he said.

It is a significant change in the way the business is conducted, and GPs have had to respond.

Another change that is not likely to be undone is tied to the increase in entrepreneurial activity.

SoftBank Impact Disrupt VC
Guleri

Early stage company building hasn’t altered fundamentally in the past 15 to 20 years, said Tim Guleri, a managing director at Sierra Ventures.

But one thing that has changed is deal sourcing, in part because of the activity at the seed level and the pricing. The seed funnel is larger, and more companies require watching, he said.

A-round VCs have had to adopt new ways to source deals.

At Sierra, that has meant investing earlier, Guleri said. “We are writing more seed checks inside a fund.”

It also led the firm to look globally. Sierra has younger partners combing Israel, Canada, Japan and Mexico. That was never the case before, when there wasn’t the inventory of companies coming out of the geographies.

Don’t expect it to reverse.

To build a portfolio of 30 to 40 companies, a firm must look at many orders of magnitude more companies, Guleri said. GPs have to throw a wider net.

Technological complexity also has changed the way GPs operate, though it may not be fully recognized at present.

“I think we are seeing more specialization” in the role of the GP, said Robert Ackerman, a managing director at AllegisCyber Capital. This is likely to continue, he said.

VCJ Cybersecurity
Ackerman

One example is cyber security, where AllegisCyber operates. Another is biopharma, where the sequencing of the genome has opened up complex new avenues of investment.

“I am very much an old-school venture capitalist,” Ackerman said. So starting and building companies, and coaching entrepreneurs, haven’t altered all that much.

But understanding technological details and establishing proprietary deal flow has.

Building proprietary deal flow was one goal behind the Maryland incubator DataTribe, which Ackerman co-founded and which he describes as a return to venture’s roots.

With DataTribe, AllegisCyber doesn’t have to compete with other VCs for deals or pay prices that squeeze returns, he said. In July, AllegisCyber led a deal for DataTribe’s Prevailion.

Over time generalists may find themselves relegated to the late stages of investing, where technology risk is less.

Ritter

In many ways “the Series A industry is still a cottage industry,” argued Emergence Capital General Partner Gordon Ritter. “You just have to be more focused than in the past.”

At Emergence, that has meant zeroing in on SaaS and cloud and now three priority themes. It has brought obvious benefits to the firm.

There are no generalist investors anymore, because no generalist GP can have the conviction necessary for the full spectrum of today’s technologies, Ritter said.

It is this conviction that will be necessary as specialization, capitalization and diversification help navigate a shifting venture landscape.