Venture capital in its traditional form is an amazing product for the right companies (and a great career path for the right investors). This is proven out in the data, as the industry’s impact punches above its weight relative to how much capital is deployed in the sector. A 2015 Stanford study found that VC-backed companies were responsible for 57% of the market capitalization of all US companies founded since 1979.
Over the last decade, institutional investors and corporations deploying capital have looked to the technology sector for growth that they’ve struggled to find elsewhere and at the same time, as the common trope goes, every company new and old is now a tech company.
This expansion of interest from investors that back VC funds and the seemingly consensus perception of an increasing market into which VC dollars can be deployed has led to the record influx of capital into VC firms that anyone reading is likely aware of.
But venture capital can be a very blunt force tool and one element of the “every company is a tech company” market expansion that many LPs, VC, and founders under-indexed on for a long time was the idea that some of the technology and technology-enabled startups being built would be better served with more targeted financing arrangements more suited to the markets they operate in, the products they are building, and the goals of the founding team — especially at the early stages since the decisions made at the outset around whether to jump on the venture track or not have an outsize impact on the long term arc of a business.
The ecosystem’s need for more aligned capital options is starting to be met by a new wave of firms, investing what I will call Precision Capital.
Before jumping into Precision Capital, I’ll quickly comment on the notion of 3rd Wave referenced in the title. Essentially, I see Precision Capital as an evolution of the early stage venture model building off of the Partner-Driven model pioneered by firms like SV Angel and Floodgate and then off of the Platform model brought to life by First Round and others. I defined those two categories in a Twitter thread on the topic and believe there is a ton of innovation happening within those two segments of the market as well.
The idea that early stage ventures can and should pursue other forms of financing beyond typical VC is not new.
As CoVenture’s Ali Hamed noted in his recent post about Equity Efficient companies, SaaS loans and venture debt have long been a piece of the capital stack and are becoming more and more prevalent with the growth of SaaS Capital, Lighter Capital, and Clearbanc among others.
These firms are early players in the Precision Capital segment of the market, where firms bring to bear a holistic capital stack tailored to the specific needs of companies in a certain industry or with a certain business model and intend to become a one-stop shop for most or all of a given venture’s capital needs — if not forever, then at least until the company reaches a scale where traditional late stage or public market financing options are available and applicable.
The idea is to give companies the option to get off the VC track or avoid it in the first place while still seeking high growth and global scale (have your cake and eat it too, I guess).
The long term commitment to a specific vertical or type of company in need of new capital solutions allows these firms to establish a unique data set and deep operational capabilities with companies in the space and, over time, pull more and more promising ventures away from the pure-play VC track and into their sphere.
By offering alternative financial products (non dilutive capital, revenue agreements, etc.), the model also has the potential to shift the risk/return curve for LPs looking to access growth in industries where technology is playing a bigger role but who are not interested in the power law dice roll of traditional venture capital or unable to get into top tier firms in the previous categories.
The combination of these elements is what distinguishes Precision Capital from vertical focused venture funds or “quant” oriented VC-track efforts that are actually (very interesting and needed) evolutions of Partner-Driven or Platform Capital models.
To be clear, a lot of this will still look like venture capital in the near term and not all the firms will run the exact same playbook (just like in more traditional VC).
This is because proving out a successful Precision Capital strategy will require firms to first show they possess a traditional VC skillset — sourcing, selecting and supporting great companies — that is supported by a unique structural edge. They will also need to exhibit patience and a repeatable framework to build a long-term data asset that can be used to underpin new financial products.
One exciting example of the Precision Capital model comes from Urban.us, a great firm focused on backing early stage urban technology companies. True to Precision Capital form, Urban.us started off with a small seed stage venture fund before expanding to run an accelerator with Mini, the automaker. The success of these two efforts have given Urban.us the credibility within the markets that matter to them to start branching out and playing a larger role in the non-equity pieces of the capital stack for the companies they work with.
Exploring the growing universe of non-equity options for startups ways by providing non-dilutive funding to operate fleets of EVs and residential batteries or to find funding for co-living projects. We see a growing list of emerging city assets that could be financed without requiring founders to sell more of their companies.
Other examples include Circle Up (Ryan Caldbeck), a firm whose quantitative approach to CPG investing has already helped a large number of companies take a different approach to growth, and Indie.vc, whose equity model is less dependent on chasing large follow on rounds and generating billion dollar exits.
In addition to these firms and others like them, I believe there are interesting ways for family offices and corporations to run the Precision Capital playbook and will write more about that down the road.
Challenges of Precision Capital
As with any new innovation, Precision Capital has a ton of drawbacks and is worse in a lot of ways relative to more traditional VC funding models.
Even an investor like Bryce Roberts of the aforementioned Indie.vc, a pioneer with an outstanding track record in seed stage investing, lost 80% of his LP base when when he “stuck his neck out” to focus his investing on Indie.vc.
A few major challenges I see:
Infrastructural Inertia — Every few months, I come across a Twitter thread or article lamenting the 2 and 20 VC model…how it can create counterproductive behavior from VCs (grow AUM, collect fees), is a function of lazy thinking from LPs, etc.
What is more likely happening is a process that starts with career risk aversion and lack of incentives to change at the LP level — don’t want to rock the boat too much for one of the smaller asset classes by allocation percentage — and filters down to VCs dependent on that institutional capital deciding to focus their “differentiation” story on how they will deploy the capital instead of fighting battles to change the culture and incentive structure at the LP level.
This creates challenges up and down the capital stack for firms wanting to employ a different model and requires them to do more work both in finding the right LPs and in telling their story once they gain an audience.
Opportunity Size — I recently read two very insightful pieces of writing — one from Ezra Galston of Starting Line VC in his quarterly LP letter (h/t Dave Ambrose) and one from Fred Wilson — that use the frameworks of other top investors to make points about the importance of being able to gain conviction around market opportunities that don’t yet exist — but could and should.
Fred Wilson’s partner, Brad Burnham, calls this “finding the narrow point of the wedge”.
The analogy is trying to hammer a piece of metal into a block of wood. If the metal is large and flat, you can’t do it. But if it is narrow and thin, you can. And, of course, once you get the narrow point of the wedge into the block of wood, you can hammer it all the way in.
Some of the best companies have been built in markets that looked small initially to investors and employees that may have passed on getting involved — there were no predecessors from whom to accurately gauge the size of the opportunity and many missed these opportunities as a result.
Similar blind spots — from both LPs and potential employees needed to build out the Precision Capital — will prove challenging for some early firms to overcome, especially if they are trying to come to market before they have fully proved out their ability to execute on a less complex VC strategy.
Today, it is unclear how many verticals, business models, or industries there are that are:
- Meaningfully underserved by the VC model and
- Present a large enough financial opportunity for this model to grow beyond just a handful of niche-focused boutique firms and attract real institutional capital.
Operational Complexity — This goes for how the firm is run and for what impact the capital will have on the ventures receiving it.
In addition to building out a team that can operate many elements of the traditional venture model at a high level — again, the idea with Precision Capital is generally that firms are still aiming to back high growth, global scale companies — these firms must attract and retain individuals capable of evaluating new types of risk and deploying capital into that. The uncertainty around what type of profile will best fit in with these firms may may make recruitment a taller task.
Firms must also consider the long term implications of the capital they are providing to ventures and ensure that they are not layering on too much complexity to companies at too early of a stage.
Data will also be crucial in capitalizing on the opportunity, creating another element of complexity that firms need to solve for over time to execute effectively.
Time — I’ve pointed this out a number of times already, but in order to execute this model effectively, firms must “ladder up” over many years, building a reputation with others in the ecosystem and gain trust that they can execute effectively with an new, unproven model.
Urban.us has had to prove their seed stage investment chops in urban tech for the last half decade, Bryce Roberts of Indie.vc has almost a 20 year track record of early stage success, and CircleUp is sitting on heaps of data that had to be meticulously gathered and analyzed over the years to make their algorithmic models what they are today.
So another characteristic of successful managers under this model will likely be patience around firm growth, as many strategies will be quite capital constrained thanks to vertical focus areas & time needed to fully capture datasets to allow for useful new capital solutions.
As Chris Douvos put it in a recent Twitter conversation:
The last true risk premium is time. All else has been arb’d away.
To twist the famous words of Andy Grove, “only the patient survive” in the early stage investing market and those providing Precision Capital are in the exact same boat.
Get in Touch!
I am an early stage venture investor based in Paris with a passion for working with companies that elevate human well-being, performance, experience, and opportunity. For the last 3 years, I have been on the team at TechNexus, a Chicago-based firm that invests at the intersection of the venture and enterprise ecosystems.
You can email me at brett [at] technexus.com or find me on Twitter.