Mark Goldberg knows how much the venture capital market has changed in recent years. A partner at Index Ventures, Goldberg remembers the days when investors would meet up on Monday mornings to sip cappuccinos, pore over pitch decks and dig into due diligence. But in today’s record-breaking market, things look a little different.
At his firm, lengthy investor meetings have been replaced with blocked calendar slots in case a partner has to sign a last-minute term sheet quickly. “The whole way that we have organized has changed to adapt to the market, ” Goldberg says. “Now capital is on demand. You can get a round done in 24 hours from a traditional VC fund and a host of new entrants.”
The due diligence process for a potential startup investment is extensive and entails gathering market data, rifling through documents of financial data and getting to know a company’s founders and customers through interviews.
This exercise used to take months on average, but in today’s market, venture capitalists have a week or two for the process — if they are lucky. Most are left to cram months of diligence into a weekend or in some cases, a single day. VCs have adapted streamlined strategies built on efficiency — all while attempting to avoid sacrificing quality.
For many that has meant making the process more fluid than formal. VCs aren’t waiting for companies to come pitch to them, instead they are constantly tracking and gathering insight on startups that could be potential portfolio companies in the future.
Multi-stage firm Felicis Ventures even hired a head of research in 2021 to assist with this. Frontloading the work gives VCs a “prepared mind” — as multiple investors put it — allowing them to move quickly when presented with a term sheet. “We’ve done months and months of work that is invisible to the founder,” Goldberg says. “The diligence is more intensive now. It’s just you have to pick and choose your battles and be ready on a minute’s notice to say yes. You need to make a decision three months ahead.”
Seed-focused micro fund Bowery Capital says its small team has managed to fit the process into two to three weeks but can push really hard to get things done faster if needed. Bowery general partner Mike Brown tells Forbes that operating on an expedited timeline has pushed the firm to give more weight to new areas of due diligence.
“We really over-index on the team and clear their prior execution ability,” Bowery says, noting that as a seed investor these decisions surround a potential 10-year plus relationship. “If there is one thing we can’t get wrong with this stuff, it’s picking the wrong founders.”
As a solo general partner, Nisha Desai, the founder and managing partner at Andav Capital, says last year forced her to be incredibly disciplined with her time to make sure she gives herself enough time to properly research and prepare. Thankfully though, she thinks founders have also leaned into the dynamic.
“I will say founders have gotten smarter about due diligence. I rarely get deep or even do a first call, until I have enough information,” she says. “That’s something founders should recognize for solo GPs, our biggest asset and most valued asset is our time. We are only going to spend time with you if we think something is there.”
The compression of due diligence comes in lockstep with a huge new influx of capital into the venture world. On the seed level, the number of firms has grown from about 120 in 2013, when Pejman Nozad started his firm Pear, to “thousands” today, he says. Solo shops like Desai’s Andav Capital are also picking up steam. In some cases, angel investors have “morphed into more of an institutionalized firm,” says Defy Partners founder Neil Sequeria.
The abundance of capital has, in turn, allowed companies to raise money at an unprecedented rate, says IVP general partner Jules Maltz. Hopin, a virtual events startup in which Maltz’s firm invested, has raised four funding rounds since June 2020, in the process growing its valuation to $7.8 billion from $245 million. “Historically, 18 months was a good time period between one round and the next round,” Maltz says.
Although the most active investors in 2020 were blue chip venture firms, the first half of 2021 saw crossover funds Tiger Global and Insight Partners take pole position, according to data from Crunchbase. “The hedge funds and public investors who’ve come into the private markets have pushed the existing private investors like us to start upping our game on how we do diligence,” Maltz says.
But while venture shops have been forced to adjust to the hedge fund playbook in some ways, they are also changing the industry on their own terms. “One thing I think Andreessen Horowitz started, which isn’t often attributed to them, is this investing strategy where you put massive amounts of money into a seed deal which has nothing substantial yet to validate the valuation.
Yanev Suissa, managing partner of SineWave Ventures, a firm which specializes in public sector guidance for startups. The logic for these heavyweights, with whom SineWave often co-invests, is that one huge success in the portfolio is enough to validate all the high-risk bets.
“I think the other traditional bigger venture funds are going to be forced to follow that trend,” Suissa says. “They’re already starting to, and they’re going to keep doing it even if there isn’t a ton of financial discipline associated with it. That will be a problem going forward that every venture fund is going to have to navigate.”
Forbes reported in December that data connector startup Airbyte raised funds at a $1.5 billion valuation despite its annual recurring revenue not yet reaching $1 million. Another example in Andreessen Horowitz’s own portfolio is the data infrastructure startup Anyscale, which raised at a $1 billion valuation in December despite reports that its annual recurring revenue was below $5 million.
Cofounder Ion Stoica contends the company’s open source origins justified its valuation markup because it created a market even before sales commenced. He points to successful open source companies like Databricks and Confluent as precedent; even still, both firms were valued at half the price of Anyscale at the same funding stage.
In the case of Databricks, the company had $12 million in revenue ahead of its raise. To Ben Horowitz, who has invested in both Databricks and Anyscale, the influx of unicorns is simply a sign that VC is finally starting to reflect the market reality.
“I do think people get confused by the numbers when you look at them versus historical valuations,” Horowitz says. “In some ways, everything was undervalued in venture capital by a lot in that we were doing deals for very cheap for things that could be worth $100 billion. Pricing is catching up to what’s actually going on in the world.”
I am a senior reporter for technology, covering venture capital and startups with a focus on Silicon Valley and the greater West Coast. I am based out of Forbes’ San Francisco bureau, where I previously covered tech billionaires as a wealth reporter, and wrote about artificial intelligence as an assistant editor for technology. I graduated from Duke University, where I spent time as news editor for The Chronicle, the university’s independent news organization. Follow me on Twitter at @kenrickcai and email me at kcai [at] forbes.com.
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