Models for Positive Selection Bias in Venture
I recently moved to Madrid and am learning quickly about the set of great local investors building out the Spanish tech ecosystem. One striking feature of the landscape, compared to San Francisco, is the number of firms. Madrid, perhaps like New York twenty years ago, has a limited number of institutional firms, and those firms are generally on fund three or four, not ten or twelve.
I'm bullish on the Spanish market overall, and believe competition will only increase among the venture community. So, the firms today need to think about their differentiation in a future state with many competitors.
VC firms sell a commodity product, euros (or dollars). They bundle it with other products such as governance, advice, and, sometimes, 'services' but ultimately the business works when the firm provides capital to exceptional founders and gets much more capital back many years later.
Firms start with great individual investors (GPs). Through their charisma and talent, they identify and network into great deals and build a track record that attracts other founders, talented colleagues, and additional capital to invest. Through the first several funds, this works great. The challenge, however, is that the time of this limited set of individuals cannot scale, and pretty soon all the initial key investors have full portfolios, with limited capacity to take on new investments.
I see three models for how a VC firm can transition at that stage to continue to attract great founders, and build an enduring franchise that extends beyond the initial set of investors. There are successful Silicon Valley investors in each model.
- Network the GPs. Some firms, recognizing the most scare resource is the GPs, build systems a processes to leverage the time GPs. A central database of contacts and resources emerges and tools to open up rolodexes to the portfolio. The firm hires a team to provide support within this network, and a 'concierge' like approach to founder support. A firm like A16Z fits this model.
- Extend the Brand. Another approach is to invest in brand of the firm overall, above the names of individual GPs. Exclusive Founder events with notable thought leaders. A media and content strategy built around enhancing the mystique and prestige of the firm. Become the 'exclusive' firm, signaled in everything from the website (or remove your website entirely). Sequoia and Benchmark follow this approach.
- Network the Portfolio. Finally, some firms invest in tools to develop the peer-to-peer learning in the portfolio. Founders want to join the club because of the actionable advice and support they get from peers in the community. The firm spends time and resources to ensure those relationships can form efficiently. YC is the most notably success here, but First Round, QED and many others do this as well.
Each of these strategies can be successful, as shown by the examples in the US market. The 'right' strategy depends on the natural inclinations of the founding GPs, and the appetite to invest in the approach. Paul Graham and Jessica Livingston are very different people than Marc Andresseen and Ben Horowitz. Each found 'founder-strategy' fit with their own model over time.
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