“The job of an investor is not to predict the future. It is to see the present clearly.” – Benchmark Capital Partners.
In the highly competitive world of venture capital, standing out from the crowd can be a key factor in success. With so many funds vying for the attention of promising startups and progressive LPs, having a winning venture capital fund model and a clear differentiation strategy is crucial.
While there are many approaches to venture capital investing, it’s becoming increasingly clear that only a few models are likely to survive and thrive in the future. These winning models will be those that can deploy capital quickly, those that specialize in particular sectors or stages of development, and those that are large and well-established, with a reputation for success. By understanding these models and the importance of differentiation, aspiring venture capitalists can better position themselves for success in this exciting and rapidly evolving field.
The first type of venture fund that will likely thrive deploys capital quickly. This type of fund has streamlined investment processes, with teams that can quickly evaluate potential investments and make investment decisions with minimal bureaucracy.
In “Playing Different Games“, Everett Randle references the velocity of investment, which is the speed with which a venture capital fund can deploy capital into startups.
The velocity of investment has a disruptive impact across two dimensions: 1) With startups today moving at a much faster pace than they did in the past and many companies achieving significant growth and success in a short period of time, venture funds that move slowly or take too long to make investment decisions may miss out on the best opportunities. Increasing new entrant competitive pressure coupled with ‘winner-take-all’ power law characteristics place increased importance on access with the VCs who can build quick conviction, typically securing allocations. 2) Most funds think about investing pace in terms of deployment schedules, typically 2-4 years. After determining a deployment schedule, fund managers focus on maximizing returns on each investment in that period. The two levers that make up a fund’s eventual profits generated from any given year of investing are fund returns and capital velocity. By increasing velocity, fund managers can generate more gains per year of deployment. As long as LPs are OK with the returns you’re now generating on an IRR/MoM basis, fund managers can make LPs more money with this higher velocity strategy, because they can invest more money with you relative to traditional fund strategies (see below).
Figure 1: Capital Velocity Impact
There are several examples of venture capital firms that have built successful businesses around rapid deployment. For instance, Microtraction, an early-stage venture capital fund based in Nigeria, has built a reputation for making fast investment decisions and deploying capital quickly. By investing in a large number of startups each year, Microtraction is able to diversify its portfolio and increase the likelihood of finding the next big winner.
The second type of venture fund that will likely succeed in the future is one that specializes in specific areas or industries. As the business world becomes more complex and competitive, it’s becoming increasingly difficult for generalist funds to stay on top of all the latest trends and developments in every industry. On the other hand, specialized funds can focus all of their attention and resources on a specific area, allowing them to develop deep expertise and build strong networks of contacts within that industry. This, in turn, can help them identify promising investment opportunities and generate higher returns for their investors.
Specialization is also key to success in venture capital. “Specialization and Success: Evidence from Venture Capital,” a study from MIT, found that venture funds that specialize in specific industries or technologies tend to outperform those that don’t. This is because specialized funds are better equipped to identify promising startups and provide value-add to their portfolio companies. By focusing on a specific area, they can develop deep expertise and networks that give them an edge over more generalist funds.
One example of a specialized venture capital firm in Africa is Newown Partners’ Imperial Venture Fund, a Pan-African firm focusing exclusively on investing in supply chain and logistics technology startups. By focusing on a particular sector, Newtown Partners has built deep expertise in this area, enabling them to identify and invest in some of the most promising supply chain and logistics technology startups globally.
Size and reputation
The third type of venture fund that is likely to thrive in the future will be one that is either large or reputable. Size and reputation are important factors in the venture capital industry, as they can help attract top-quality startups and co-investors. Larger venture capital firms are able to make larger investments and can afford to take on more risk. Additionally, reputable firms are able to attract the best entrepreneurs and startups, giving them a competitive advantage over their peers. Large funds have the advantage of having more resources and a larger network of contacts, which can help them identify and evaluate more investment opportunities. Meanwhile, reputable funds with a proven track record of generating strong returns for their investors will be able to attract top-quality startups that are looking for reliable and trustworthy investors.
As Forbes reported in their article “Andreessen Horowitz Is Blowing Up The Venture Capital Model (Again),” larger funds are becoming more prevalent. This is because larger funds can continue to support and provide more capital to their portfolio companies in later stages. Additionally, larger funds can afford to hire more staff and provide more support to their portfolio companies, which can be crucial for startups looking to scale.
An example is CRE Venture Capital, a pan-African venture capital firm that focuses on investing in startups across various sectors, including healthcare, fintech, and e-commerce. CRE has a large fund size and a reputation for being highly selective in their investments.
It’s worth noting that these three types of venture funds are not mutually exclusive, and many successful funds will likely possess characteristics of all three. For example, a large and reputable fund specializing in a specific area may also be able to deploy capital quickly. Likewise, a fund that deploys capital quickly and specializes in a specific area may become large and reputable over time as it generates strong returns for its investors. As the industry becomes more competitive and complex, these three characteristics will become increasingly important in helping funds stay ahead of the curve and generate strong returns for their investors. As an investor, it’s important to stay ahead of these trends and adapt to the changing environment in order to succeed in the long term.