The Ethics of VC — how is the professionalisation of the industry going to affect its ethics? (#8)
It’s rainy here in London and I just came home from afternoon tea with an old friend of mine. He has recently moved from banking into the tech world where he helps startups to do fundraising. His business model is simple but so far rather unusual for the startup world: taking a cut from a capital raise. He has taken a practice that is the absolute norm in finance — the position would be called a ‘private capital advisor’ — and implanted it into a new sector. What my friend was offering was the kind of professional service that VCs weren’t used to for the longest time.
This made me think of something that I have been observing for a while: the VC industry is slowly professionalizing. As more and more capital has been flooding the private markets over the last decade of zero-interest rates, VC has seen an insane growth (of about 5x globally since 2010). Growth comes with exposure, with impact, with scrutiny — and eventually with professionalization.
Nicolas Colin traced that trajectory — the professionalization of an industry — about three years ago historically for Goldman Sachs (and more generally investment banking). More recently, he also wrote about McKinsey and the consulting industry. I spoke with him but also many other VCs over the last three years and asked many of them: how do you think the industry is changing at the moment? Nobody called it ‘professionalisation’ but many talked about exactly that. Here are four of what I believe are the biggest ongoing developments:
- Firms are becoming bigger and more corporate (or smaller, boutiquey and micro). Historically, VC-firms operated like Benchmark: as intimate, long-term partnerships where everyone does everything (minus an executive assistant or two). No juniors. No special treatment. All on one layer. More recently, firms like Insight (which looks like a bank in its corporate structure and hierarchy titles) or A16Z (wow — the team size here) have grown massively. Even just within the investment team, hierarchies in this firms look more like normal pyramids; often firms would split into specialised functions and even offices. At the other end of the spectrum is the trend to the micro-VC, small funds, at times run by a single GP, often highly specialised. More and more of VC money is funneled through such vehicles for LPs ‘seeking alpha’ (i.e. a unique way into the market). Both approaches can work, however — there is no clear market winner.
- Functions are splitting up — and sometimes are even outsourced. Related to the growth in AUM, VCs are increasingly not just about investment anymore. In a founders-market where the best startups can choose where they take money from, VCs have to differentiate themselves and offer value-add ‘services’. A16Z is a good example again: they have a whole hoard of these services. From marketing and recruiting to tech and operations, they provide all kinds of support for their portfolio companies. But not only do VCs take over more functions themselves, some functions are even outsourced to special new companies. Mountside Ventures, for instance helps VCs (and founders) with fundraising — just like my friend does. Others firms such as Sevanta or Dynamo facilitate dealflow management; again others help with portfolio and LP management (e.g. Kushim). A whole professional service-provider market system is developing.
- VCs are internationalising. Surprisingly few VCs have historically operated in more than one big market (at least when we are looking at early stage) between Europe, the US and Asia. Only over the last decade have VCs truly become international. Sequoia now has three separate vehicles in the US (with several offices between the two coasts), Europe (they just opened London) and Asia (with big presences in both China and India). Accel has at least got London, New York and SF covered. While having global offices — a big commitment — , might still take a while to spread more widely, cross-border investments have indeed become much more common (see Lerner’s new research on foreign investment in US, for instance).
- Data is (slowly) starting to play a bigger role: historically, gut feeling, warm introductions and networks have been shown to be highly influential in how VCs make investment decisions. Now, some firms have started to base several kinds of decision more on (quantified and hard) data. Correlation Ventures applies predictive analytics to its investing; eVentures identifies early investment opportunities using (marketing) algorithms, Social Capital uses it to do (part of its) due diligence; Capital T deploys data tools to do away with warm introductions (and identify strong teams up front). The number of firms really basing decisions on data is very small, still, (see Forbes for an overview), but there is a trend.
The question that interests me most, however, is this one: how are these developments going to affect how VCs make decisions, reflect, are motivated and how overall the industry is structured?
Based on my observations and conversations, let me lay out three hypotheses:
- Less ethos, less trust. Some VC veterans told me with pathos in their voices how nice it was to share all the dealflow and invest together in the beginning; these days are surely over as the industry is maturing. It has become more important to stand out to attract founders as a VC than to work together on getting new ideas funded. A certain ethos — what some more seasoned investors described to me as the spirit of Silicon Valley — is in the process of getting diluted in this way. Many claim that SV — and with it to a degree VC — was founded on principles of (hippie) collectivity, engineering genius and an eagerness to solve problems together (see O’Mara’s history for instance). Professionalisation will do away with this attitude. Increasingly, becoming a VC is also up there on the list of ‘hip professions’ for MBA grads —flooding often boringly polished same-heads into VC. If people come into a field and see it as a profession, a step in their career or even worse a pit stop, the atmosphere will change and so will decision making processes.
- More professional, really. We might see a possible effect of the professionalisation on the overall processes of accountability and justifications in VC. With the rise of ‘professional services’, the increase of AUM, scrutiny will increase. With more and more people entering the industry in wider networks, the power of the closed group will diminish. Trust based systems (hand shakes) could be increasingly replaced with contract based systems. Due dilligence will not be short-circuited with a simple ‘co-invest with Sequoia’ kind-of-herding anymore. Gut feeling as a force of decision making might increasingly be pushed out — or at least needs to be justified retrospectively. But so could warm introductions and the importance of Stanford-alumni networks — and obviously this also comes with some advantages for so far overlooked groups, see below.
- More diversity soon (but not necessarily more inclusion). Professionalisation and increased scrutiny is slowly gnawing away at the old-white-boys club that VC was born as. While real results (particularly on partner level) have yet to appear, we are already seeing lots of pressure on ‘the industry’ to push for a more diverse set of people in decision making capacities. More and more data shows how few female investors we have (see the NVCA/Deloitte report on the US, for instance), how few black ones (see the Black report on the UK) and as a consequence also how little money goes to overlooked founders.
The increasing professionalization — and influence of research and insights about the (financial) benefits of it — will drive more diverse hiring in the medium turn (on a junior level this has already started). But we might have to wait another while until we are really going to see equity and proper inclusion; so far, the lauded ‘hire and wire’ — real action — is really lagging behind (see recent news on the lack of money for Black/LatinX founders in the US).
I am keen to keep observing how these hypotheses and others are developing over the coming months and years; how many conversations begin that will hopefully lead somewhere but also how many end nowhere. I am unsure for whom ‘professionalizing VC’ will be good/the best yet, but it is has definitely started big time. With all its ‘uncomfortable challenges’ it might provide a chance to change existing power structures for the better.