One of the ways I describe venture capital as an asset class to those considering investing is that it’s like a very lumpy, long-term annuity. An annuity requires a lump sum up-front investment for guaranteed payments at a later date in time. It’s a phase shift, or a time dislocation, moving money from now to some time in the distant future. Whereas an annuity has next to no risk, but also next to no upside, consistent allocation into venture capital can provide a long run dislocation of capital, but with higher risk and also much higher potential future returns. It’s a “lumpy annuity.”
If you’re bearish on today, but bullish on tomorrow, you might want to shift some of your capital out into this future set of opportunities or outcomes. You might also want to consider the cost of holding onto your capital today, and the purchasing power erosion you might experience if your money is not growing with the economy. In other words, you might want to allocate into venture capital, because this is a bet on the future, and a time shift of smaller returns today for bigger returns tomorrow.
And if you’re a founder, you might want to allocate your time, your human capital, phase shifted out to a future you can see that’s necessary, and better than today. Entrepreneurs are optimists about the future, and so are venture capitalists.
One of the most common refrains one hears on panels today is that exit markets are bad, and if you look at the data this is empirically true. IPOs are well below the traditional steady state rate, even accounting for the 2020 and 2021 SPAC bonanza.
There is a lot of self loathing introspection about the prognosis of venture capital as an asset class based on a few years of aberrational data. Many wannabe Francis Fukuyamas (the political scientists who famously wrote on the “end of history”) herald the “end” of venture capital once a week. But like Mark Twain quipped, “the report of my death was an exaggeration.” Similarly, the death of venture capital is likely an overstatement, if for some period of time the exit hurdle has gone up.
What’s not an exaggeration is the blunting of the term venture capital to be far too inclusive of non-risk taking activities. Whereas a few years ago many hedge funds and PE firms ran “down market” into venture capital, today some of the largest “VC” funds have clearly just grown into PE. In Spanish venture capital is synonymous with “risk capital,” and is known as “capital de riesgo.” In English somehow we’ve lost that notion, with a parade of me-toos claiming to do venture capital, but only seeking relatively risk-free businesses with cookie cutter KPIs, like “$1-2 million in ARR.”
Venture capital is by definition the few percentage points of frontier capital that finances opportunities that cannot be supported elsewhere in the economy. Venture capital as mainstream is, I believe, an oxymoron. By definition, it is the highest risk-bearing capital. Here’s to the crazy ones, the Internet entrepreneurs, the web3 infrastructure builders, the creators of the space economy. Simply requiring every company get to “$1-2 million in ARR” is antithetical to frontier risk taking, and therefore lower market private equity lamenting the loss of VC returns, while having completely forgotten what it means to take venture scale risk.
As an asset class the very expansion and inclusiveness belies the definition of what the function of VC is; namely to take frontier technology bets that are not being financed by other market mechanisms. Inclusivity as far as who is performing this allocating is wonderful; inclusivity in the definition of VC is oxymoronic.
The other common refrain I hear existentially muttered from “expert panels,” is about what the death of unicorns means, and lack of public market liquidity. What many fail to realize, going back to the time dislocation of venture capital, is that for current cohorts of investments, all that matters is what the world looks like phase shifted out 5-7 years. Commentary on today only matters coming from those who were in the market 5-7 years ago. We think of these cycles at Everywhere Ventures, and we’re of the strong conviction that this cyclicality lends itself to two phases of opportunity.
When exits are bad, there is an “illiquidity discount”
This means that current valuations deflate, and things are cheap
This means that many entrepreneurs are fearful, so better ones stick around
This means that under-convicted LPs leave the asset class
This means that stalwart investors are buying in at a massive discount
To us this is a “risk on” environment, because we’re focused out in 5-7 years
When exits are good, there is a “liquidity premium”
This means that current valuations balloon, and everything gets overpriced
This means that startup tourists flood the market chasing riches
Bad founders abound and it’s hard to separate wheat from the chaff
Non traditional LPs flood the market chasing returns
Tier 2 funds that can’t win access to top deals pay earlier forward valuations
To us this is a “risk off” environment in which to exercise caution
This is a great time to harvest winners, and sell into the glut of demand
When you next hear a panelist describe the “death of venture capital,” or the “exit window being shut,” think to yourself about time dislocations in venture capital, and how indexing into this set of cohorts affords the best discounts for future wins. For those investing today with a heavy illiquidity discount, all the better for tomorrow. For those considering building a company, today is the best possible time to create the future you want to exist in 5-7 years, and venture capitalists will agree.
The definitions of venture capital have not changed, but the parade of wannabes has expanded, and the death of returns greatly exaggerated. Exits still exist for those investors boldly backing zero-to-one, risk taking companies, and if the market is tight today, that only means the illiquidity discount gives you an advantage for tomorrow. The Buffet adage holds true; be greedy when the world is fearful, and fearful when the world is greedy. Keep your own map of where you think we are in the cycle. If you’re a founder, lick your chops, because if you wade into this market, you’re not only bolder than most, but your very courage is a stamp of self-selecting validation that you’re hungry, you believe in tomorrow, and you’re a fighter. If that’s you, let’s chat.
Scott Hartley is Co-Founder and Managing Partner of Everywhere Ventures. You can also read his work Everywhere with Scott on LinkedIn or his Substack.
Listen to Samantha Coxe chat with Allison Stoloff on the Venture Everywhere Podcast: Flaus First. Now on Apple & Spotify and check out all our past episodes here.