The Traditional Venture Capital Model Is Being Disrupted
October 13, 2021 — Boston
Changes in the venture ecosystem have important implications for asset managers and investors
The venture lifecycle, which involves providing capital to entrepreneurs in staged funding rounds, is being disrupted by changing technology, new players, more capital, and a globally dispersed playing field, according to the latest Cerulli Edge—U.S. Asset and Wealth Management Edition.
The business of financing innovative startup companies has always been dynamic, attracting increasing amounts of private capital based on its relatively high risk-adjusted returns. Multiple drivers, including technology, are shaking up the traditional venture ecosystem and unlocking new opportunities and new ways of doing business. For instance, investment in technologies such as the cloud, artificial intelligence, and collaborative tools have dramatically lowered the cost of starting and more quickly scaling a business. The greater reliance on intangible assets such as cloud computing has driven down unit hardware and software costs, thus making it cheaper for startups to experiment and helping to create an explosion of new startup companies globally.
Venture investors have also become increasingly diverse, bringing different skills, venture experience, and investing motivations. Nontraditional venture investors, including hedge funds, private equity groups, mutual funds, pension funds, and family offices, have overtaken traditional venture capital groups and currently make up half of the top-10 investors in startups by dollar amount.1 These investors tend to be pure providers of capital and therefore do not take board seats or get involved operationally, and often have lower return thresholds than venture groups.
More capital flowing into venture investing by a greater variety of investors is both a response to the changing focus of venture and it is also a driver of changes today and likely into the future. Greater competition for financing rounds puts pressure on investors to specialize—e.g., in terms of the stage of investment, the sector, and geography. Across stages, the pace of investment is accelerating as investors race to scale companies and create the next “winner-take-all” global platform. The COVID-19 pandemic accelerated nascent consumer and business trends, such as e-commerce and remote work, thus stimulating entrepreneur startup activity. U.S. healthcare, especially biotech and pharma, received more than $20 billion in investment in the first half of 2021, not far off 2020’s record $27 billion.2
The ongoing disruption of the venture ecosystem has important implications for the industry’s key players. For fund and asset managers, intensifying competition to identify and finance innovation should encourage venture firms to create relationships early with entrepreneurs and make sure these partnerships are long-lasting to enable asset managers to benefit from winning companies longer. With venture exhibiting the greatest dispersion of returns between top and bottom quartiles and persistence in returns, it is critical for investors and asset owners to be highly selective of the managers with which they invest and ensure their performance track records and investment discipline are attractive.
1 Source: PitchBook
2 Source: PitchBook
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