Innovations in Venture Funding Gain New Limited Partner Interest

Open Core Summit in December, hosted by OSS Capital, a firm dedicated to investing in commercial open-source technologies, is the largest COSS ecosystem gathering in history (200~ speakers, 100+ sessions, 10,000+ attendees). OSS believes that open source software and platforms will power the next generation of disruptive technologies. During my talk at the Open Source Summit held in November, OSS founder Joseph Jacks asked me to describe some of the changes that are taking place in venture investment, particularly with regard to LP stakeholders. The biggest shift, in my view, has to do with changes to the ways that the most promising venture-backed companies are being formed and funded.

Over the past two decades, innovations in cloud computing, SaaS, and mobile technology have driven down the costs of seeding tech startups. Generally speaking, starting a tech company now requires less initial capital than ever before. As a result, the past decade has seen an explosion in the number of startups launched, making it more difficult for traditional venture firms to identify and capture the best companies. In recent years, various specialty accelerators and studios have emerged to address this problem.

TI Platform Management has long been recognized as a leader in generating innovations in venture capital funding. Proven entrepreneurs have described TI Platform as a “Y Combinator for prominent founders” due to the firm’s assistance and involvement in the formation of 20+ such firms with disruptive new venture structures, such as accelerators and studios. These models are now gaining increased traction, and are changing the face of venture investment for everyone involved.

Institutional investors faced with a welter of proliferating opportunities have begun to change their strategies for capital deployment in response to these trends. Historically, LPs have scrambled to gain allocation in a handful of oversubscribed brand-name venture capital funds that have already proven their success. Now, greater numbers of LPs are warming up to new models in venture funding structures.

Several additional factors have contributed to this increased receptivity for new venture structures among LPs, who are typically more conservative investors. First, top-tier venture capital funds have seen significant and accelerated churn, making it harder for LPs to place continuous bets on the same funds. Second, low-interest rates have pumped private markets full of excess capital. This surfeit of private capital has compounded the existing effects of less expensive technologies and a baseline technological infrastructure, in the form of cloud computing, that facilitates numerous downstream innovations. The capital surplus in venture also means that venture capitalists no longer hold the same advantages they had in the past: founders can be choosier about whom they select as investment partners, and savvy founders prefer to accept capital from investors who can provide strategic guidance, as well as a network of connections that will facilitate the growth and success of their businesses. Unlike the public market, where a portfolio manager picks securities or companies to back, the venture market allows startup founders to select their investors.

Accelerators and platforms leverage brand and network effects

New platforms and accelerators modeled after the wildly successful Y Combinator (YC) program have begun to proliferate in response to these conditions, yielding fruitful results by leveraging network effects among a growing community of alumni entrepreneurs. Companies that emerge from accelerators benefit from an instant community of peers and more seasoned entrepreneurs and venture investors, allowing them access not only to priceless advice but to top talent, as well. The tremendous success of landmark companies to emerge from accelerators and incubators—such as Airbnb, Dropbox, Snowflake, and Palantir—has caught the attention of LPs endeavoring to capture outsize multiples for their institutions. Platform models with brand and network effects such as YC are able to capture a highly curated funnel of start-ups and cut through the noise before doubling down on breakout companies.

Founded in 2005, Y Combinator continues to lead the pack, having produced some of the most successful startups of the past decade, including AirbnB ($100B IPO), Coinbase ($28B projected IPO valuation), Doordash ($72B IPO), Dropbox ($10B IPO), Instacart ($18B IPO), Reddit (~$3B valuation), Stripe ($100B valuation), and Twitch ($1B valuation). The market value of all YC companies to date is more than $386B, with over $175B in exit value. The YC program has been so successful that someone who invested in an index of all Y Combinator companies would earn between 200x and 400x on their investment, even with dilution factored into returns.

The emergence and unique advantages of venture studio models

Like accelerators, venture studio models have begun to attract the interest of LPs. Venture studios differ from accelerators in that they recruit startup team talent and scalable business concepts simultaneously. After bringing together a critical mass of successful repeat entrepreneurs and the industry’s top talent in engineering, marketing, and growth, venture studios are able to pair compatible team members with business projects at the pre-seed stage, and then support them as they scale.

VC studios are more active and hands-on with their startups than accelerators; studio GPs take on co-founder positions and offer additional in-house services and infrastructure to support multiple startups. Venture studios earn significant equity from their startups—anywhere between 30% to 90% at inception—in exchange for the various top-level resources the studio provides. More importantly, many studio ventures are founded by prominent entrepreneurs, which makes them attractive to other entrepreneurs, who often seek to join and co-found companies alongside repeat winners. Standout successes among studio ventures include HVF, founded by Max Levchin, Science, a studio that incubated Dollar Shave Club (acquired by Unilever for $1B) and has 5 other exits and Atomic, which was founded by Jack Abraham. Abraham is the founder of Milo, a company he sold to eBay at the age of 24.

A recent headline-grabbing graduate of the studio model is Snowflake, which was incubated by Sutter Hill and its CEO Mike Spieser. Snowflake’s 2020 IPO was the largest software IPO ever, and the fifth-largest for a company in any industry. The sensational IPO event attracted even the staidest investors, such as Warren Buffet’s Berkshire Hathaway, which invested in the company.

No alt text provided for this image

TI Platform Management has been acknowledged as a pioneering firm for our early and sustained relationships to new venture structures; the firm has a strong history of anchoring studio models, including Entrepreneur First (a hybrid of the accelerator and studio models), Merantix (a machine learning studio), Science, and Atomic, a studio that just saw one of its portfolio companies, Hims, go public with a unicorn valuation.

In our experience, new venture models offer four qualities that are increasingly attractive to limited partners. First, LPs can invest in projects led and advised by iconic entrepreneurs such as Elon Musk or Peter Thiel, and gain direct exposure to a portfolio of startups incubated by serial entrepreneurs who obtain capital from tier-one VCs. Second, investing directly in a studio enables LPs to attain equity stakes in promising, well-resourced, and well-advised startups without going through intermediaries like venture funds, which usually charge them a premium layer of fees and carry. Third, studios also offer a greater ownership stake in high-quality startups co-founded by proven entrepreneurs at a lower cost. Finally, studios allow LPs to gain access to high-quality, pre-seed investment opportunities before they are well known to others.

It is no secret that LPs are increasing their allocations to venture given the recent success of that asset class over the last few years. As more founders choose to join accelerator programs and venture studios, and as more venture capital funds focus on the later stages of funding, LPs have become increasingly interested in exploring new avenues for allocating capital to early-stage ventures, to complement their existing venture strategies. Because the studio model develops and supports startups from seed to scale to exit, they represent a uniquely attractive opportunity for LPs, who typically invest over the long term. Furthermore, as capital becomes more plentiful, many traditional venture firms have raised billions of dollars and invest at many later stages; these firms have started to look more like private equity firms than traditional venture firms focused on early-stage businesses. Firms raising capital for seed-stage and early ventures will find that LPs, particularly those without long-standing connections to top venture managers, will be increasingly interested in gaining exposure to early-stage companies that stand to benefit from the unique advantages offered by accelerators and venture studios.