SoftBank disrupts Venture Capital

At this point I’m sure you’ve heard of the $100B Softbank Vision Fund that’s been making headlines around the world. With all this news traditional VCs now feel the need to keep up so they don’t get “left behind.” While this may seem like simply a PR/branding problem, it has fundamentally changed the industry with far-reaching implications. While some of the headlines below may seem ridiculous, it’s time to see what happens when the disruptors get disrupted. This change isn’t necessarily a bad thing.

http://fortune.com/2018/01/08/term-sheet-monday-january-8/

http://www.businessinsider.com/sequoias-reportedly-raising-a-new-6-billion-fund-2017-12

https://www.recode.net/2017/12/20/16804282/sequoia-raising-new-fund-6-billion-softbank

So lets break down how this happened, what it means and what affect it will have on the overall investing ecosystem:

1. Softbank first announced their $100B Vision Fund in Oct of 2016 with a simple press release on their site. https://www.softbank.jp/en/corp/news/press/sb/2016/20161014_02/
2. Apple a few months later confirmed they committed $1B to it. https://techcrunch.com/2017/01/04/apple-joins-softbanks-vision-fund-with-1-billion-investment/ and you can see everyone else who invested here https://news.crunchbase.com/news/softbanks-100b-fund-league/
3. This completely overshadowed Greylock’s announcement of their $1B fund a few weeks prior. https://techcrunch.com/2016/10/10/greylock-closes-1-billion-fund/ and Andreessen Horowitz raised their fifth fund of $1.5B in June 2016 too https://a16z.com/2016/06/10/fund-v/

This $100B vision fund was announced two years ago but was probably in the works way before that. I’m sure a lot of insiders knew about it — which is why a handful of major VC firms raised huge funds in 2016 and now two years later are coming back for more. Even if most of the capital hasn’t been deployed and returns are definitely not realized.

1. This brings us to today. The $100B fund has already deployed over $40B in capital ($10B more thanks to Uber) that is basically more than all the other VC funds combined. I don’t know how much overlap there is between the Vision Fund and Silicon Valley VCs. It would be an interesting project, if someone wants to find that out (to see if they directly benefited).
2. As you can see from the headlines above, the tech press is allover traditional VCs for now having “small” funds in comparison to something at the time was unfathomable. Why? The economics of a $1B fund (which I still consider huge) only required the VC to product $3–4B in returns at best, which is still insanely hard to do but feasible as they’ve proven.
3. Now that Softbank has “forced” the VCs to basically compete at the highest level for the top deals — something they only did between themselves — the economics are fundamentally changing. A $6B fund now has to return $18-$24B, which has never been done before.
4. Softbank is literally disrupting the venture capital world which is known for disrupting everything else. So where will all this additional liquidity come from?
5. IPOs, traditionally the biggest exit for investors, have been picking up steam recently. Hopefully through the repatriations of hundreds of billions of dollars, M&A will continue to increase too.
6. VCs usually have an ownership thesis of 10–30% of a startup in accordance with their business model. So for a $6B fund that needs to return $20B to their LPs, they will have to create $60-$200B in value over the next decade to be considered a success. It’s entirely possible but anecdotally only one Uber, Snap, Airbnb or Pinterest is created each year, so competition will heat up as the battle for the next big thing begins.
7. Are ICOs and crypto the answer? I don’t think so — they’re just todays trending topic as VCs begin to diversify and find alternative investments that can give them the returns they need. That being said, there is still money to be made there.
8. On twitter I said that I look forward to VCs soon doing more PE style deals through buyouts and restructuring. Now that the VCs are being disrupted, they need to find new models for generating returns — I think it’s entirely plausible that they can acquire entire companies or take others private to significantly increase their ownership stake.
9. Another question is if they will continue with the traditional 2/20 model as well? For a $6B fund, the management fee every year would be ~$120M and assuming they’re successful, they will split billions in returns to all their partners as well. Not too shabby.
10. We do need to remember though that this is a long game. Most funds have a “life” of 10 years, so while it seems crazy today, assuming everything works out meaning it continues going up and to the right, the numbers aren’t as daunting.

This is unprecedented territory but I have faith VCs will figure it out. It’s a quality we look for in our founders and something I know these VCs have — not to mention, they’re also so much smarter than me. Now that we understand a little more about how the actual business of venture capital is changing, we now need to figure how it affects the actual businesses they’re investing in.

1. As I mentioned in my previous post, I think pre-seed/seed will stay steady but the deals sizes will increase. These new VC funds will need to deploy more capital and writing $1M checks in seed, even some Series A companies just won’t do it for them. A few of their “scout” programs will pay off — maybe even give a few of their founders some capital to invest in things they like as well.
2. With so much later stage capital that needs to be deployed now, look for a increase in the Series B+ startups that are showing some traction and potential. Unfortunately because of the increased competition, I feel we’ll get a few fighting term sheets as they need to compete over valuations. Back to the days when banks/PE thought they could invest but with smarter capital.
3. Companies are going to stay private longer, a phenomenon we’ve experienced the last few years with so much cheap capital available. Why IPO and face the public markets / just ICO and get free money (kind of a joke). Liquidity will always be an issue, I’m just more concerned about the employees with stock options vested that turn into golden handcuffs.
4. Get ready for herds of unicorns to run wild — we’re going to see a lot more. This isn’t necessarily a bad thing if a lot of the capital goes to things that will actually improve life, work and hopefully the world. It’s great that all this money will be put to work — just please less emojis, LOLcats and avatars…
5. All this capital will basically make them growth stage investors, that want less risk and slightly less return multiples. Why invest $100M in a riskier company for a 5x when we can do $300M for 3x and make more? Or as I mentioned before, taking a larger % of companies as well.
6. Some competition in hiring will occur at the earlier stages as talent who may have joined a startup instead get recruited by the VCs. Startup life is high intensity and very stressful and those who understand it can also be the ideal candidate for the VC world. With these enormous cash infusions, I’ve seen a lot of VCs create huge teams that try to differentiate themselves by providing outsourced work for their portfolio companies. A cost they will have to realize at some point.
7. Also more competition between startups as there is only so much human capital and top talent to go around. Why start a company, get paid less and work harder than working at a growth company backed by top VCs, more resources and liquidity on the horizon?

While this may seem negative, I want to make it clear that it’s a good thing. There is so much capital out there sitting around and I truly believe that most of this will be put to good use — funding innovation, hiring professionals, and creating real businesses. There will be some huge losses that look bad, people will question the businesses/founders but that’s just the world we live in.

We also have to remember as I mentioned that this is a looooooong game. Most of this capital will be deployed over the coming years, with some being held back for later follow-on as well. I’m not trying to call a bubble but inevitably over the next 10 years there will be a pullback. This will create the perfect environment for smaller investors to come back in at more reasonable valuations.

I honestly wouldn’t know what to do with $1B+ dollars as I play in the pre-seed/seed levels where all I would want is $10M+ fund to invest in 20+ startups. A rounding error for them but hopefully a necessary feeder of companies to fill the vacuum created by these mega VCs. Now when these funds are announced in the coming months, you know why and are prepared to talk about them. Good luck!