Venture Capital Risk-Taking: Trends and Changes

A Shift in Venture Capital Focus

Sam Lessin’s analysis published in The Information, titled “The End of Venture Capital as We Know It,” ignited considerable discussion within Silicon Valley. His central argument posited that the emergence of new investors possessing substantial capital is reshaping the late-stage investment environment for venture capitalists, compelling VCs to either compete in a more crowded field or seek opportunities in less competitive markets.

However, a parallel and potentially more impactful trend is unfolding within venture capital, one with even greater implications than the increased competition for late-stage deals. This trend involves a discernible move away from the core principle that has historically defined venture capital: the acceptance of risk associated with early-stage ventures.

Declining Investment in Early-Stage Companies

Available data confirms a rapid decrease in investment directed towards early-stage companies. According to reports from PitchBook and the National Venture Capital Association, the proportion of total U.S. venture capital allocated to angel and seed stages has fallen from 10.6% to 4.9% over the past three years.

Early-stage investment has also experienced a reduction, decreasing from 36.5% to 26.1% during the same period. Conversely, late-stage investment has seen a substantial increase, rising from 52.9% to 69%, fueled by new participants like hedge funds and mutual funds, as Lessin highlighted.

This shift coincides with a period of unprecedented new business formation. The U.S. Census Bureau reports that seasonally adjusted monthly business applications have averaged approximately 500,000 from the latter half of 2020 through June 2021, a significant increase compared to the 300,000 applications seen in the year prior to the pandemic.

These statistics should be viewed with concern. Venture capital fundamentally involves investing in risk to facilitate the growth of innovative and transformative concepts. However, the venture capital industry, as a whole, is increasingly prioritizing investments in later-stage companies where the underlying concept has already been validated and demonstrable momentum exists.

The expertise required for these later-stage investments leans more towards financial analysis – determining appropriate investment amounts and valuations to achieve specific return targets – rather than the ability to identify promising founders with groundbreaking ideas. While late-stage investing plays a vital role, an overemphasis on it risks stifling innovation and limiting the future pipeline of companies suitable for Series B and subsequent funding rounds.

A Favorable Climate for Inception-Stage Investment

Interestingly, the current environment presents an ideal opportunity for inception-stage investors, given the reduced capital requirements for progressing from idea to Series A funding. Access to cloud computing, social media, mobile technologies, and open-source resources has lowered startup costs, enabling entrepreneurs to test concepts and gain traction with smaller capital pools.

This has fostered a period of exceptional innovation, with numerous emerging trends creating a substantial pool of companies in need of funding and support to transform ideas into thriving businesses.

Furthermore, the value of being an early investor is consistently emphasized within the venture capital community. The key question when evaluating VC performance remains: who was the first investor to recognize the potential of a brilliant idea, rather than who led the final funding rounds before an initial public offering.

This is not merely a theoretical debate about venture capital; it will have tangible consequences for our capacity to innovate and invest in critical areas such as advancements in silicon technology, the application of biology as a technology, human-centered artificial intelligence, harnessing the power of data, climate-conscious investing, improving healthcare, revitalizing social media, and exploring blockchain and quantum computing.

The Importance of Remembering Venture Capital’s Roots

The venture capital industry must not lose sight of its foundational principles. In its early years, it served as a crucial catalyst for the success of iconic companies like Genentech, Apple, Microsoft, Netscape, Google, Salesforce, Amazon, and Facebook.

Without these companies, we would lack the biotech industry, the internet, cloud computing, social media, and mobile technology – all of which have profoundly altered our lives, leisure activities, and work patterns.

While predicting the future is impossible, the advent of AI, machine learning, and a new generation of semiconductors and materials undoubtedly signals significant change. However, this change will not materialize without substantial venture capital investment at the inception stage of companies. A renewed commitment to supporting early-stage ventures is essential.

This is not solely about individual firm success; maintaining U.S. leadership as a global innovation hub requires the venture industry to actively support bold ideas at their earliest stages, providing them with the opportunity to succeed. Perhaps, as Lessin suggested, VCs should explore “another small pond,” or more accurately, delve deeper into the existing pond teeming with inception-stage companies seeking partners for the long term.