The Future of Venture Capital

Venture Capital has faced unprecedented growth over the last decade. Even at the height of the coronavirus pandemic, VC firms have closed mega multi-billion dollar funds.¹ Combined PE and VC dry powder reached historic highs in 2020, with a staggering $1.48tn in undeployed capital.²

In this report, borne out of research we conducted for a VC client, we look at the shifting landscape and the broad disruptive forces at play in the venture capital industry.

While we were struck by the volume of new players and value propositions, we focused on the emergence of challenger VCs that are innovating in several areas to differentiate against traditional, incumbent VCs. We are seeing firms use artificial intelligence and machine learning to score deals. Smaller firms are tapping into a network of global accelerators to fuel their deal flow. Founders can reduce dilution and get greater optionality beyond debt or equity with new funding mechanisms such as revenue-based financing. More investors can now participate in venture investing with the rise of crowdfunding and tokenized offerings. Some VCs are emulating passive investment approaches seen in public markets through index fund equivalents for the private market. These firms aspire to provide increased predictability of returns by investing in a large and diversified portfolio of startup investments. The startups that VC firms invest in are by definition innovative with many of them breaking new ground. A handful of startups may end up transforming entire industries thereby disrupting incumbents.

Disruptive Innovation

As Innosight co-founder Clayton Christensen described it, disruptive innovation is the process in which a smaller company, usually with fewer resources, is able to challenge an established business (“incumbent”). These disruptive innovations drive democratization of markets by overcoming barriers that historically consigned consumption to those with expertise, specialized skills, or sufficient wealth.

Although there are early warning signs of disruption in the venture capital industry, incumbents do not face an imminent threat and disruptions often take time to unfold. Incumbents still exude tremendous power; 12% of VC funds in the US account for 66% of total capital raised. The venture capital value chain is deeply integrated; it relies on human relationships, a credible brand, a strong track record and judgment. Startups benefit from the signal value associated with top VCs, thereby further priming the VC pipeline.

In the future, many traditional VCs will adapt and respond to these challengers. These incumbent VCs will equip themselves with new technologies and business models that appeal to their investors and founders. However, we see the incumbents’ sphere of influence diffusing to an increasingly fragmented set of players.

Venture capital firms, old and new, will continue to play a critical role in the innovation ecosystem by funding promising business ideas. These early signs of disruptions suggest challenger VCs will be formidable competitors in the future.

THREE PRIORITY TAKEAWAYS

Four shifts are emerging in the venture capital landscape: democratization, deal-growth, diversification and digitization.
We see seven emerging archetypes of VC firms co-existing in the future venture capital ecosystem: supercharged incumbents, specialist VCs, super angels, venture studios, venture as a service, index-style VCs and AI-powered VCs. The latter are further from the traditional VC model and will take time to evolve and mature.
For the challengers to successfully disrupt incumbents, they must leverage difficult to replicate technology, innovate with new business models that are unattractive to incumbents and prove they can meaningfully scale. Incumbents, on the other hand, should explore the needs of non-traditional players in the venture ecosystem and enhance their internal processes.

NOTES

Some recent statistics might be skewed by the coronavirus and the increased liquidity we are witnessing in the market. Even when accounting for recent circumstances, we believe that the broader set of changes are here to stay.
The report references several different players in the ecosystem. This is not intended to be exhaustive and some notable examples may have been overlooked.
Innosight previously operated a venture capital firm, Innosight Ventures, which evaluated 500+ opportunities, made 10 investments, and had 3 successful exits.
The underlying research was funded by Hatcher+, a data-driven VC firm, referenced within the report.