“Investing in venture is a return-free risk.” -Roelof Botha, Sequoia Capital
“No. Investing in bad venture is a return-free risk.” -Yanev Suissa, SineWave Ventures
Where is Roelof correct? What is happening in the industry? How do you succeed given those dynamics? All good questions. Let’s answer them:
The Return-Free Risk Argument:
Roelof’s argument is that there’s too much venture capital and not enough profitable companies in which to invest that capital- over $150 billion across 3,000 venture funds. He notes that to reach even modest LP net returns (~12% net), the industry would require $1T+ in yearly exit value—a scenario he views as impossible. Thus, he concludes that “investing in venture is a return-free risk.” Correct argument, incorrect conclusion. Here’s why:
Quantity vs. Quality
It is absolutely true that more companies being created does not translate into more great companies being created. Thus, the more aggregate money Limited Partners pour into venture, the higher the percentage of that money that is being washed down the drain in underperforming startups.
The Mega-Funds: Skewed Risk-Reward
In some cases, it is even true that the venture model, specifically the pursuit of alpha returns, can be deemed broken. This is most notable when looking at the giant, over-capitalized Valley firms (not unlike Sequoia).
The VC mega-funds publicly espouse their “aspiration to…be the best net IRR and net multiple for [their] LPs” rather than merely to maximize fees and the like. And yet, the models they have pursued are consciously and purposefully built to do exactly the opposite.
Turning a VC fund into a $10B vehicle that invests its capital in a 2-year period dramatically skews risk-reward metrics. It requires the deployment of massive sums of capital at earlier and earlier stages, forcing higher valuations and a lack of financial discipline. The result? Mediocre returns relative to startup risk.
Impact on Enterprise Business Models
The lack of discipline across these VC funds simultaneously encourages less efficient execution and spend across underlying startup portfolio companies. Combining this with later stage growth investing, expansion to capital inefficient sectors (a great justification for raising even more money from LPs), and “evergreen funds” that hold positions in the public market, these mega-funds have created the perfect recipe for “return-free risk.”
LPs with Muted Objectives and Expectations
The mega-funds are in a different business these days. Their job is to give pensions another safe bet for a reasonable, yet unexceptional, return. They are more than happy to take the fees to do so. But alpha is still out there. It’s just coming from a different model and generation of VC firms. And not all of them. Quantity doesn’t beget quality for LPs any more than it does for VCs.
How to Make Real Money in Venture
The equation is not complicated:
- Identify the best deals
- Access to them
- Execute on those deals by providing value to your portfolio companies
- Exit those deals
Execution:
Execution on this equation can be difficult, though the requirements for success are no surprise. You need all of them, not just one:
- Identify. Build an investment team that has both the breadth and depth to create a focused thesis for the future of technology and innovation. Chasing shiny objects does not cut it, nor does the Valley bubble or tunnel vision.
This is why the SineWave team spans commercial, public sector, entrepreneurship, and venture. It allows for a multidisciplined approach that helps us make better decisions and provides a critical information advantage.
- Access. The best deals are competitive. Articulate a compelling reason to earn the right to invest in the best companies.
SineWave is one of only three early investors in Databricks because the founders knew we could build the public sector business for them, now one of their largest revenue streams. The same applies to our investments in category-defining companies like Metronome, Arize, and SentinelOne. SineWave is the established leader in bridging the Hill and Valley with an institution-level reputation for driving value for our commercial-first startups. Entrepreneurs favor investors that drive unique value.
- Execution. Demonstrate execution that drives revenue to your portfolio’s bottom line.
SineWave team members have collectively been responsible for driving over $1 Trillion of revenue from the public sector into commercial technology companies. Enough said. Even our earlier stage portfolio companies recognize these benefits, including Rescale, RegScale, Granica, and CoreStory.
- Exit. Land the plane. “You have nothing until you exit.” A VC’s job is to return money to their investors, not to hold it in perpetuity.
SineWave has driven top percentile returns for our Limited Partners. Many multiples on cash are back in our investor’s pockets, not just on paper. That is what the alpha investors should demand.
Limited Partners too often throw money at firms without accurately assessing these important variables. But if a firm gets it right, there are some added benefits in this new era of technology.
New & Improved Drivers of Venture Returns:
- Accelerated Growth Rates. AI startups that drive real ROI achieve revenue faster and scale at 5x the speed of traditional venture startups.
- Larger Exit Potential. As AI upends every business sector (i.e. when you are revamping entire technology stacks from the ground up), the size of each opportunity expands exponentially. When a company wins the game, it reaps even bigger rewards.
- A Proliferation of Paths to Liquidity. More money in the ecosystem also allows for secondary opportunities at even earlier stages of a company’s lifecycle, enhancing the liquidity prospects for an otherwise highly illiquid investment portfolio.
Punchline:
VC firms architected to be great investors, rather than merely “in the business of investing,” can still drive alpha if they have the required elements for success. LPs need to start thinking like VCs. Focus on where the ball is going, not where it has been, and have both the judgment and the courage to bet on the future winners.
