This is a guest post by Richard Armstrong who is an early stage investor in many startups in both SE Asia and globally. Plus Richard has cofounded several companies.
Guest Author: Richard Armstrong
I’ve enjoyed investing in startups as an angel investor for a number of years now and have made numerous investments.
Currently I am a Venture Partner at a leading early stage global fund with 12 unicorns and 6 IPOs under their belt.
So given my passion for VC, I figured i’d write an article that talks a bit about its history and how we’ve arrived to where we are today.
Let’s start with a brief history.
Most people say ‘venture capital’ started around WWII
Georges Doriot, a Harvard Business School professor, founded American Research and Development Corporation (ARDC) in the 1940’s.
ARDC’s investment in Digital Equipment Corporation yielded a return of over 500x its initial investment. And it was this success that drew attention and got others into the game.
Silicon Valley developed in the 1970’s
It was during this period that the iconic VC firms like Sequoia Capital and Kleiner Perkins Caufield & Byers were created.
Their investments into companies such as Apple and Genentech created massive returns while developing technologies that were clearly changing the world.
It also showcased how the VC model could drive considerable economic growth and transform markets. So in other words… VC started getting ‘popular’.
But a bit too popular.
The First Dot Com Bubble
The late 1990s and early 2000s witnessed the dot-com bubble, a period of speculative investment in internet-based companies. It was during this period that companies like Yahoo, AOL and Amazon began to really emerge.
For example, after going public in 1996 Yahoo’s stock price more than doubled on the first day. And Amazon went public in 1997 and saw its stock price by more than 31% in its first day of trading.
It was exciting times… and Alan Greenspan, the Chairman of the Federal Reserve at the time, coined the term “irrational exuberance.” That was right before things started to fall apart in 2000.
The bubble’s burst in 2000 resulted in significant financial losses for many VC firms and startups, prompting a reassessment of the VC approach. And for awhile capital almost completely dried up.
The model needed to get better at things like risk management, due diligence, and evaluating sustainable business models. And so it did.
VC expands globally in the early 2000s
By the early 2000’s VC had now expanded United States to Europe, Asia, and beyond. Particularly large markets like the BRIC’s (Brazil, Russia, India, and China) had started to create more and more successful startups, even unicorns.
For example, Alibaba, emerged in China and in 2000 the VC firm, Softbank, invested $20 million into it. An investment which would earn Softbank a gain of $72 billion in the ensuing years.
So it was stories like this that resulted in an explosion of VC firms of varying sizes and focuses around the world.
Which takes us to where we are today.
VC is now pretty mature
There has been an absolute explosion of capital in the past decade or so. In part because the LP’s (ie. the ones that put their money into VC) have seen its profit potential and have thus put massive amounts of capital into it.
For example Andreessen Horowitz now has approximately $28 billion in assets under management. And this gives them the ability to make some very big bets.
But its not just these large firms that are doing well… there are also many smaller VC firms with anywhere from $10m or so under management that are also carving out their part of the pie and making a tidy profit while doing so.
Smaller funds outperform larger ones
Venture funds smaller than $350 million are 50% more likely to generate a 2.5x return than funds larger than $750 million. That’s according to new data from Santé Ventures looking at funds raised from 1979 to 2018.
Why is this? Well there are numerous reasons… but part of the reason is that they have more flexibility as to how many potential companies they can invest in.
When you have massive amounts of capital to deploy, it simply doesn’t make sense for you to do small deals. Even if these small deals grow a lot it will still often not make much of a difference to your overall fund if you’re managing billions of dollars.
So this means much more options for these smaller VC firms that are managing $350m or less. Because there are a lot more companies looking to raise $5m – $20m than there are firms looking to raise $100m+.
Also these smaller bets, if successful, can often multiply in valuation at higher levels than larger bets. Because market sizes are limited and so big companies only have so far they can grow in their market.
Here is some data collected by Preqin on the top performing funds.
As you see 8 of the top 10 top-performing venture capital funds have fund sizes of $100m or less.
Most of these are sector-specific VC’s that deeply understand the domains of the companies that they invest in. Plus as they are small they are usually quicker to support their companies that are gaining traction.
Wrapping up
I find it a very interesting time in VC now as there is a ton of capital available, but for the past couple of years since 2021 funding has been on a pretty steep decline.
Many VC firms got burned after the peak in 2021 and so are far more tentative about doing deals.
Also there is much more pressure on investing in companies that have a clear path to profitability, which also limits the playing field of who you can invest in.
Then to top it off more and more startups are trying to avoid the VC path by either reducing their capital requirements or finding alternative funding mechanisms. In part because of other startups that had bad experiences with their VC partners.
I do, however, think that this is temporary and that venture capital will continue to play a massive role in tech innovation… particularly here in SE Asia as we are at much lower level of maturity than the US.
And there is still a ton of growth left.
