The New VC Model

Hey y’all — VC is undergoing its largest change in over 15 years.

And this week the shift became undeniable (if it wasn’t already).

Here’s what’s going on:

The New VC Model

The Status Quo

The launch of a16z in 2009 brought about the last true shift in VC.

They popularized and perfected the idea that firms should provide founders with more than just capital.

Modeled after Hollywood talent agency CAA, a16z provided founders with resources in the form of access to vetted partners, service providers, potential hires or just an expert to get advice from.

Obviously, this led to founders often preferring to take capital from them over other firms. Many chose to compete — this is why every VC today talks about their “value add.”

After 16 years it’s no longer unique (though I’d argue a16z is still best-in-class at it).

The Shift

On May 1st, Lightspeed announced they’d shifted their regulatory status and become a registered investment advisor (RIA).

But this isn’t just some boring legal update.

Now they are no longer restricted by the SEC to limit investments in what’s called “non-qualifying investments” (secondary shares, cryptocurrencies, PE-style buyouts, public stocks, etc) to no more than 20% of the size of the fund.

Lightspeed actually isn’t the first to do this — a16z was, back in 2019 before the last crypto bull run (and then participated in Elon’s buyout of Twitter), though Sequoia and General Catalyst have as well.

When General Catalyst announced a new fund last year they went so far as to say that the “traditional VC model does not best position founders to transform industries.”

With another major fund like Lightspeed shifting to this model, it’s clear things are changing more broadly than it just being a couple firms who wanted flexibility to invest in other asset classes.

The Drivers

The news articles about this say it’s driven by VCs wanting to diversify into other asset classes or wanting to buy companies, implement tons of AI systems to increase margins, and operate and scale them for profit.

While some firms with strong ex-founder and operator DNA will do this, I doubt it will be the majority — and it seems unlikely to be the actual main driver.

VCs maximize their returns by betting on outlier winners in an extreme power law system — not by operating cashflowing businesses.

And so, like usual in the startup world, VCs have the money but founders are the true power brokers.

The main driver seems to be how founders over the last 10+ years have preferred to stay private for longer, rather than IPOing.

You have to remember that each fund that a VC firm raises is built around a timeline.

Investors (LPs) give VCs their capital with an idea of when they will get it back (along with profits).

Generally funds have a 10 year horizon to return capital.

But, increasingly (and as I talked about when I covered the history of Silicon Valley), the big winners have been preferring to put off an IPO as long as possible.

You’ve probably seen the articles about it — Axios even wrote that Stripe “may never go public” and Airbnb stayed private for 12 years.

You can see the problem here.

Not only does this create headaches for early employees whose equity is at the founders’ mercy with regard to offering secondary sales, but it also creates some awkwardness for VCs and the 10 year time horizons they promised to their LPs.

VCs want that capital returned to LPs so the LPs can give some of it back to the VCs as part of a new fund. The wheel wants to turn, and VC’s winning bets have increasingly been holding it up.

So VC is adapting.

What Does It Mean?

There’s actually a lot to like about this model.

For LPs it’s obvious — they’ll have options to get their capital back faster.

For VCs, it likely expands the pool of LPs they can raise money from. I’d guess the large firms who are pioneering this are setting up individual funds for various purposes, and raising capital from sets of LPs with different levels of risk tolerance for each.

Additionally, the ability to lean more heavily into secondary shares allows them to increase their exposure to winners.

For founders, they can avoid dealing with the hassles and distractions of the public markets by staying private longer while still getting liquidity for themselves, their employees, and their earliest investors along the way.

I can see a world here where some firms have specific funds to buy out earlier investors as the initial time horizon to return capital approaches.

Most importantly, it means founders should be more focused than ever on building longterm relationships with VCs — not just pitching them when you need capital.

With more options at their disposal to get involved, founders should consider investor relations a constant part of their job.

Ironically, I also think it’s likely we’ll see the first ever IPO of a VC firm in the next 5-10 years due to this model. Maybe that’ll be a16z too.

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