In theory, the hard part about finding capital for unproven founders with unproven technologies in unproven markets should be that no one wants the risk. There was a time when that was true, but it isn’t anymore.[1] For a founder, the issue is different: venture capital is abundant, but it’s not very evenly distributed.[2]
There are groups of founders to whom this uneven distribution is an advantage. These founders are well connected or pedigreed and can use their access to capital as an advantage in building their startups. That’s good for them, and they should use every advantage they have.
But the world of startups would be better overall if capital could more easily find great startups. That should be a given, but in looking at the various bottlenecks in the system, it is clear that, at least some of the time, some of the parties involved are actively impeding access and distribution. Other bottlenecks are the result of the fact that venture markets are immature.
Manufactured impedance
Professional investors are in something of a bind when balancing accessibility and exclusivity. On the one hand, the best investors generally believe that returns are driven by significant outliers. These outliers are unlikely to come from an expected source or pattern match precisely on previous outliers. This means that investors would be best served by having the largest possible funnel and the least biased filtering mechanisms. In other words, investors should treat any and all inbound investment opportunities as potentially incredible and equal weight their attention to them.
However, this presents a set of problems. Investors who tout their willingness to look at everything equally and actually do so will lose their auras of exclusivity. This aura is important in convincing founders to contact the investor and later when investors try to win deals - when given the opportunity, most people choose exclusive clubs over inclusive clubs.
Then there’s the practical problem: capital may be abundant, but good people and their time are scarce. Let’s say, for instance, an investor decides to follow the “evaluate all inbound” model. This investor actively markets that she’ll meet every company that emails her. The strategy works and the emails pour in.
That investor will then need the time to meet hundreds of companies each week. Software can help route and filter, an application process can eliminate some number of in person meetings, but the investor will need partners and staff to deal with volume.[3] New partners and staff cost money, which means raising more funds. Larger teams and larger funds start to impact exclusivity, as does the greater numbers of investments dictated by adding people and looking at more companies.[4] Investors who want to pursue the abundance path will get caught in a recursive loop that seems dangerous to their model.
Structural impedance
The other set of barriers to capital distribution exist because venture markets are relatively new and immature. There are many markets without local venture capital investors. Foreign investors may be interested, but face challenges in understanding the nuances of those markets and those founders.[5] This impedes the flow of capital to companies that should get it.
Because venture markets are relatively new, they are also unnecessarily opaque. Information within these markets is rightly viewed as incredibly valuable, and so it is rationed by those who have it. This makes it hard for new entrants with money to figure out where to put that money. Instead, LPs are required to route it through the professional venture investors that have access to information about what companies are raising and which are not. The analogy here would be an equities market which forced university endowments to call hedge fund managers to discover what stocks exist.
There are a number of other structural bottlenecks to evening out the distribution of capital. What is so interesting about these and the manufactured bottlenecks is that they could all be solved by either a new common set of behaviors, or an intermediary that made it significantly easier for startups to access the sources of capital already looking for them.[6]
This is the second in a set of essays drawn from watching the interactions between investors and founders during several hundred Series A and B in the last few years. If you are wondering how this dynamic impacts your company, please reach out at a@aaronkharris.com.
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[1] See https://blog.aaronkharris.com/abundant-capital
[2] Apologies to William Gibson for bastardizing one of my two favorite quotes about the future and technology. The other is from Arthur C. Clarke: "Any sufficiently advanced technology is indistinguishable from magic."
[3] Operating under the assumption that the investor can successfully generate inbound interest.
[4] Partners at venture funds are primarily evaluated on the quality of their investments. This means they have to actually make investments, especially early in their careers.
[5] When Rappi first launched, US investors failed to understand the radical differences in their economics relative to US counterparts. These differences were driven by dramatically lower employment costs and urban densities that were only apparent if you’d studied Latin America enough.
[6] To some extent, YC’s Demo Day does this for seed stage companies. However this function has not yet been replicated at later stages.