The World As It Is
Building a startup as a first time founder is hard, really hard. You’re creating something (hopefully) new, you’re convincing cofounders to come onboard and cover the shortcomings in your skillset and available time, you’re convincing users that they can trust something unlikely to be around in a years time and you’re doing this all with limited resources because you’re a totally unproven quantity. You’re also doing all of this without any real understanding of whether you’re doing things right. That’s completely normal. That’s the accepted process. You’re (hopefully) tackling a problem you care about, and through pure will you’ll build something new.
However, by the time you feel comfortable with this stage of the process, you’ll be out of it. You’re confident your core assumptions are right, you’ve raised some money from some speculative angel investors and you’re starting to build a team to get to a place where product market fit could look reasonable. You’re on an elevator of building out your product, gaining new users, expanding your team and raising more capital to fund that growth. All the time your job is changing. You’ve gone from MVP builder to scrappy team leader to scale-up and at every stage you’re unlearning the previous stage and learning the next.
The truth is that this is what our system normally looks like, and it’s worked. It’s given us almost every company that we know today, but it’s not efficient. Companies with so much potential die at the earliest stages because they don’t have the right mix of product, distribution, knowledge, access and network required to execute their vision - all because the cost of acquiring those factors is so high when attempted on a non-repeatable basis.
Enter Venture Studios
Venture studios look to build a process out of the early stage - building the means to validate ideas, gain funding and build teams for them on a repeatable basis. Venture studio LPs replace the position of a traditional pre-seed investor. Instead of providing capital to a basket of hand picked early stage founders, capital is provided to a systematised process of company creation. A process that encapsulates a more efficient way to build the pillars of an early stage startup.
Building A Team
Convincing someone to leave a stable, well paid and high status job is tough. Sometimes the allure of independence, ownership, impact and the fun of early stage company building is enough. Most of the time it isn’t. Very few startups succeed and many people can’t take that risk, completely excluding them from the startup talent pool. Venture studios increase the size of that startup talent pool. They provide a route for risk-averse talent to benefit from early stage value creation without sacrificing the job security and benefits you gain from being part of a more stable organisation. Whilst the potential of a larger talent pool allows venture studio to be more selective, and hire better quality talent, the model also better incentivises the team.
Large companies suffer from a principal agent problem. You want to incentivise an employee to maximise value. One of the best way of doing that is to give them equity in what they create. The more they do, the more the company grows, the more their equity is worth. This logic checks out for small companies where an individual moves the needle on company progress. However, when a company becomes larger, any individuals work matters less. Now your effort isn’t proportional to your reward. The game becomes to minimise your effort for the same reward for any financially driven individual. This has paved the way for the “Rest and Vest” culture in big tech where actions become politically driven, not value driven. Venture studio teams operate at a size that maintains the impact an individual can have on the success of a product, directly tying team performance to reward and thereby mitigating the principle agent problem.
Building Product
Building an early stage product is different from the process you experience in a large, more established, company. When you don’t have a large pre-existing userbase the cost of iterating quickly, at the expense of being rigorous, is much lower. You can afford to make mistakes and build what users want quicker, outpacing the competition. However, that arises in the wake of losing the established tooling, internal libraries and institutionally held domain knowledge you have available in a larger company. That trade-off is made manageable by the fact that those developer resources are optimised for large company structures, not building at the early stage.
Venture studios have the best of both worlds. The ability to iterate quickly at the beginnings of a product and build engineering process optimised for the early stage. Most tech products have a very large overlap in technical requirements. User auth, payments, CRUD operations (the list goes on) are all pieces of functionality that can have their UI and back-end implementations transferred between projects given congruent technical stacks. Where an early stage CTO is building that functionality from scratch, venture studios can transfer component libraries and default implementations between projects - massively speeding up the engineering process and allowing you to ship product quicker.
Gaining Users & Building Partnerships
“If you build it, they will come” an adage that has never been so untrue. Good distribution matters, and gaining your first 1,000 users is often harder than the next 10,000, especially in the case of network driven products with a cold start problem. Understanding growth channels, building audiences and making people care about what you’re creating is hard. However, when done once those learnings and audiences transfer.
Partnerships are also extremely hard for a new enterprise. The resource needed for an established company to work with a startup isn’t justified when the probability it’s not around in a years time is so high. This effect is so severe that it’s often better to just not create companies that rely on external partnerships from the get go. However, a track record allows venture studios to pursue partnerships that are out of bounds to startups operating in a classic model.
Raising Capital
It’s no secret that founders with previous successful exits have a much easier time raising capital for new projects than first timers. An existing network of capital and a reputation for having done it all before allows them to raise rounds quicker and at higher valuations. Conversely first time founders need to both generate a network and convince them that they can execute on multiplying their money successfully. This is a huge time cost to founders that should be working on their business and, where early stage valuation is a function of investor interest, they have to accept a lower valuation with less investor optionality.
Repeatably building businesses that require seed funding allows you to cultivate a transferable network that solves that problem. A network with which you have rapport, a reputation and a fair marketplace. Accelerators, such as Y Combinator (YC), did exactly this. YC demo day provides startups with the YC seal of approval and an extensive marketplace to fairly value them. Venture studios benefit from the same effects, allowing them to decrease the time investment to raise funding, and drive the best possible valuation in a wider market.
The Problems
Funding founders with a specific vision, team, metrics and traction is one thing. Writing a cheque to fund a set of ideas that haven’t yet been had is another one entirely. A venture studio founder faces a much higher bar to capital than a traditional startup founder. That narrows the candidate pool to a much smaller number of people, often with previous exits under their belt and a more established reputation. The pool of potential capital is also narrowed from the investor point of view. Each investment firm has an investment mandate, and a commitment to their LPs not to deviate from that mandate, venture studios aren’t a traditional venture investment and may fall afoul of what general partners are allowed to fund.
Building a structure to efficiently found companies that consumers want is all well and good, but without an off ramp that effort is entirely wasted. Valuations from the next round of funding mean nothing unless those companies have the capability of later undergoing liquidity events. To reach that stage, a business needs excellent leadership that shows a sense of ownership over the business. Startup founders naturally come into that sense of ownership. They built a company from nothing and so have an emotional connection to what they’ve built. Encouraging the same mentality in leaders that come into existing businesses that they haven’t originated is tough.
Wrapping Up
Venture studios aren’t a golden bullet. I’m confident in saying they won’t replace the traditional model of founders looking to remake a market in their image. However, they have key structural advantages in building businesses and the proportion of venture dollars that go towards pre-seed rounds, as opposed to venture studio funding, seems hard to justify. Given their efficacy, It’s my prediction that the number of venture studios will trend up heavily in the next ten years. As they do I expect them to differentiate like the venture market has - branding themselves as targeting different verticals, channels and model types.