Bridging Final Gaps in Frontier VC Markets
Last week, I wrote about what matters when thinking about potential VC fund returns in a new market. I'm still working on data sets around that inquiry, but it has also led to a number of helpful conversations with leading investors in Madrid about the Spanish market specifically.
Igancio Larru made two terrific points to me that are worth remembering:
- C- Level talent. As companies scale, it isn't the founder or the market that is the constraint. Nascent markets lack deep pools of executives with previous experience scaling growth stage tech companies. Leveling up your leadership team in SF or New York after a $50M Series C round is easier than trying to be one of the first to build a local team at that level in a new market.
- Continuation Funds. Similarly, new VC markets tend to start with Seed/Series A focused funds. Even if those are successful, as I believe the early vintages have been in Spain, the scale of the breakout companies quickly outpaces the ability of local funds to continue their support. A 250M Euro fund can't write 50M Euro checks.
In both cases, these constraints are not binding. Great founders can still raise capital from funds in other markets, as many European entrepreneurs already do today. They can recruit talent globally. But in both cases there is more friction. Another challenge for founders to overcome.
My initial reaction to these insights was this doesn't matter to the returns of the Seed/Series A fund. The company may relocate to Silicon Valley or go public in New York, but neither action changes the returns to early investors.
Ignacio's point, however, is that these additional frictions make it much more likely a founder will sell rather than keep battling. Exits in new venture markets tend to be smaller. This is the reason. It isn't because founders are less ambitious, or because the ideas have less room to grow. Founders, and their early investors, operate in a less supportive environment for scaling these good ideas. So many sell early.
Of course, this isn't universally true and it won't be true forever. There will come a time when markets like Madrid mature for both executive talent and capital markets. Anticipating that inflection point is a compelling LP strategy for backing managers in an emerging VC ecosystem.
In the meantime, Seed and Series A funds are built around providing good returns without requiring massive exits. Price discipline on entry valuations. Greater number of smaller exits that provide 10x-25x returns, rather than the 100x+ returns typical of the 'winners' in Silicon Valley funds. Fund returns can still be attractive, just with different portfolio construction.
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