Here Comes The Fund, Do Do Do Do, The Mega Fund
By Nathaniel Whittemore
On February 2, 2012
In a blog post Tuesday, 3-year old venture firm Andreessen Horowitz announced its third fund, a $1.5 billion monster that brings the firm’s total capital under management to $2.7 billion.
The news not only cements the firm’s place among the upper echelons of the Silicon Valley VC elite, but is one of the strongest indications yet of an ongoing transformation in the distribution of venture financing.
For entrepreneurial dreamers, venture capital is a near-mythical world that opens the door to Zuckerbergian success. For more seasoned entrepreneurs, VC is a resource that can be anything from a necessary evil to a valuable asset that brings with it expertise and connections, depending on who one is working with.
For the people and institutions that actually invest in venture capital firms, however, VC is something different: it is a high-risk, high-reward asset class that adds diversity to a complete financial portfolio.
Venture firms work by raising money from what are called “Limited Partners.” These LPs are usually high net worth individuals (often successful entrepreneurs in the past), corporate actors, university and foundation endowments, or pension funds. Particularly for endowments and pension funds, investment in venture capital is not driven by a romantic belief in the power of entrepreneurs, but a financial decision that is meant to put a small portion of the overall resources they manage in an asset class that could have significantly higher-than-market returns on the back of an explosive growth company like Facebook.
The past decade, however, has been a tough one for VC as an asset class. As the bubble burst and the artificial returns of late 1990s initial public offerings dissipated, the class has had a hard time keeping up with historical performance, and as those massive wins have fallen out of 10-year indexes, LPs have begun to notice.
Even as venture capital has rebounded on the hopes that the maturation of social technology platforms like Facebook, Groupon, Zynga, and LinkedIn will lead to big public market exits, LPs have begun to focus their assets on a smaller top tier of firms who are able to get into the best deals. What’s happening now is a consolidation of resources around both the demonstrably best performing firms, as well as the firms that have captured the Valley Zeitgeist.
This is actually two separate but related trends: first, the consolidation of resources around a smaller number of firms, and second, the importance of entrepreneurial mindshare in building a successful firm, particularly for those involved in early stage companies.
The need for entrepreneurial mindshare reflects the growing power of founders relative to funders. As the cost of starting a company has come down and as the resources for founders to become more sophisticated entrepreneurs – most notably the rise of venture accelerator programs – have increased, the best startups have become more choosey about the money they take.
Some of this choosiness is a mark of more sophisticated thinking, as startups look for firms that have an aligned vision, experience with their particular industry, and a reputation for friendliness to entrepreneurs. Some of it is a little less sophisticated, being driven by the trendiness of a particular firm at a given time. A huge part of the choosiness is based around a hard-to-prove but also hard-to-deny belief in the value of signaling and optics of investment from a high-brand-value firm.
Regardless of the reasons, it is undeniably true that there is a gravitational pull around certain firms that draws in entrepreneurs and which simply doesn’t exist for others. This is a powerful asset for firms, giving them a sort of proprietary dealflow that actually creates a cycle of self-fulfilling prophecy. In other words, if a firm is perceived to be one of the best, and thus attracts the best entrepreneurs, it can actually become the best on the strength of its portfolio, regardless of the original veracity of its bestness.
There are many interesting ways that firms are amplifying these signals. Social media has become a channel for radically differentiating oneself through intelligent thoughts and personality. Fred Wilson from Union Square Ventures, Paul Graham from Y Combinator, and Ben Horowitz – who starts every blog post with a hip hop lyric – are a few of the investors who have taken to heart Jay-Z’s proclamation that “I’m not a businessman, I’m a business, man,” and used writing to dramatically amplify their presence.
Boldness of vision is also extraordinarily attractive for companies. Call it what you will, Andreeseen Horowitz’ early Skype deal showed the entire Valley that they were here to play. And no one has put so much emphasis on differentiating through vision as Founder’s Fund, who published a manifesto last year called “What Happened To The Future?” and whose website proudly declares “We Wanted Flying Cars, Instead We Got 140 Characters.” Founders Fund recently closed a $625m fund.
The moment we live in, then, is one in which pressure from the bottom – the desire of entrepreneurs to be associated with the firms that they, rightly or wrongly, believe to be the “best” – and from the top – the desire of LPs to be invested only in the small handful of top tier firms that will produce the lion’s share of the asset class’ returns – is centralizing resources in the hands of a much smaller number of investors.
How permanent this shift is, of course, impossible to know. But in the near term, what it portends is the rise of the megafund – a notion that is not so much about the pure size of assets under management but the power of a small handful of investors to capture the entire industry’s attention and leverage that position to the ends of proprietary dealflow and lavish LP desire.
Indeed, what is most remarkable about Andreessen Horowitz’s latest raise is not simply it’s size but the fact that it took only 3 weeks to raise. The paperwork took twice as long.
Here comes the fund, do do do do, the mega fund. It’s alright.
Nathaniel Whittemore is a Principal at LearnCapital where he invests in the next generation of education technology companies. Previously, he was the founding editor of the social entrepreneurship portal on Change.org, and founded the Center for Global Engagement at Northwestern University to design programs for students interested in social change. He writes regularly about startups, venture capital and impact for publications like Fast Company, Inc, and GOOD, and lives in San Francisco, CA with his deaf rescue pit bull, Isis.
