The Commoditization of Venture Capital

The venture capital market is getting more and more irrational every day. VentureBeat just reported this week that VCs are ‘collecting logos’ of unicorn companies.

According to Pitchbook, more than 60 percent of all VC-invested capital went to rounds of more than $25 million in 2014, the highest percentage since the dotcom boom. There were 414 rounds of $25+ million last year, 50 percent more than the 276 rounds in 2013. VC capital invested jumped $20 billion from 2013 to 2014, while the number of financings fell by 16 percent.

Historically, private company valuations have largely been tied to valuations in the public market. But there is now growing concern that VC valuations have exceeded reasonable public valuations — a dangerous sign. Facebook’s $22 billion acquisition of WhatsApp has inflated valuation expectations. Meanwhile, potential tech buyers such as Google, Yahoo, Alibaba, Apple, and Microsoft have tens of billions of dollars in cash holdings. Series D+ valuations saw a 50 percent jump from 2013 to 2014. Valuations now exceed some of the closely watched historical exit parameters. We’ve also seen a significant increase in median Series B valuations. Capital invested in late-stage rounds was up to $11.5 billion in Q2 and $10.6 billion in Q4, representing the only two $10+ billion quarters since the dotcom boom. Seed rounds declined to 221 in Q4 versus 564 in Q1 2013.

I discussed the danger of overvalued private unicorns in Why Not All Private Unicorns Will Become Public Unicorns earlier.

And you’d think experienced investors like Kleiner Perkins and Andreessen Horowitz would know better.

Reading through the CB Insights data, we find that Kleiner Perkins Caufield & Byers piles up unicorn logos, with 12 currently, but it hasn’t invested in a single one at the early stage; meanwhile, Andreessen Horowitz has 10 unicorns, but only two were early-stage investments. These VCs are willing to stomach zero-percent returns on these companies because it’s probably worth the payoff they get in terms of higher visibility.

In other words, some of these venture capital funds are now, essentially, what used to be called “mezzanine-level” funds and are investing at what may someday seem to be crazy valuations — meaning this may be a very risky game. This “unicorn riding” at high private valuations is likely what is driving the comparative venture return benchmark so high. And I doubt that these private valuations are real and sustainable.

Apparently not.

My observation: the venture capital business is commoditizing.

There is a ton of money in the seed stage. [Read: Why 70k Angel Financings Is A Problem]

There is a Series A Crunch. [Read: Series A Crunch]

There is tremendous competition from VCs for validated Series A, Series B and Series C deals. This is where the real commoditization is happening.

And then there is this absolutely dumb behavior happening that VCs are collecting logos in late stage companies showing unicorn potential and bidding their valuations up to unsustainable levels.

If you ask a regular, traditional venture firm what their strategy is, you’d get incredibly wishy-washy answers from most of them. Part of the problem is that there are too many of these firms, and they are not differentiated. They have no positioning. No real strategy. Their deal flow sucks. And if they can accidentally find a good, solid, high potential deal, the entrepreneurs use them to negotiate with other firms, and unless they are Sequoia or Benchmark (or Andreessen Horowitz), they cannot win the deal. [Read: Who Are The Top VCs in Silicon Valley Today?]

From this, I have to conclude that the venture capital business is commoditizing. Entrepreneurs are learning that if they can bootstrap to validation and present a well thought through investment thesis for building a venture scale business, there are many takers. The negotiating leverage is in their hands, not in the hands of the VCs. Unless you are willing to go in early, develop deep relationships, competing in mature Series A, B or C deals is going to be brutal.

Your thoughts and observations are most welcome!