Key points:
- Venture capital investing is necessary for most companies to receive the capital, expertise, and support they need to become successful.
- Investing in the venture space requires an understanding of the high-risk nature of the industry and the potential for failure.
- The venture space can be rewarding for those with the risk appetite and expertise, with the potential for exponential growth.
- The current market cycle has made it more difficult for ventures to raise funds, but this also presents investment opportunities.
- AI is driving venture opportunities, particularly in the technology sector where it can revolutionize small businesses.
- Operational execution is becoming increasingly important in the venture space, requiring a focus on management and team-building.
Everyone knows how Amazon AMZN started as a simple book store or how Meta began in a dorm room. At some point all of today’s great companies were just a passion project, a great idea in need of capital, employees, and the first real customer. While some ideas grow to become companies organically without outside investors, most companies need help. They need capital, they need expertise, they need connections and support. Venture capital investing is the process by which these great ideas get funded and become dynamic companies capable of scaling and growing profitable.
You can’t invest in the venture space without recognizing that failure is an essential part of the creative process. Venture companies are dreaming big – and not every moonshot works out. In fact, most small companies end up failing and shutting the doors. Investing in the space successfully hinges on one or two ventures succeeding within a much broader portfolio. The companies that make it often hit escape velocity – they can hyperscale and the the returns can be exponential. The returns on a single venture investment could be enough to justify dozens of failures. The complexity of the market is further complicated by the lack of transparency and minimal reporting requirements. The environment is rife with fraud and exaggeration. A great idea may be nothing more than an idea and may have no substance or practical marketability. Successfully navigating the venture space consequently requires a nuanced understanding of how businesses are run and an astute approach to avoid falling prey to exploitation. Subject matter expertise is also essential to see through the sales pitch and understand the substance of the idea. Finally, we have to take a moment to discuss how hyperscale growth can be risky even when it succeeds. Unlike mature companies who are kicking off cash to investors, most venture investments are purely growth oriented.
This already exciting space is even more intriguing because of where we are in the market cycle. Smaller companies are typically the most exposed to the broader economic cycles and the venture space is no exception. The past two years are a great example. Inflation and interest rate hikes put a damper on the economy and small companies took it on the chin. Exuberance in 2021 turned into austerity in 2022; it’s hard to overstate the monumental shift in perspective. Think about some public market companies with established user bases and real products – companies like Teladoc or Zoom or PayPal. In 2021 their valuations were extended, and in 2022 and 2023 those valuations came tumbling downwards.
We believe a stressed venture market represents a great investment opportunity. A stabilizing economic environment, attractive valuation rounds, proved out concepts, and a burgeoning wave of innovation is an exciting combination. While we believe there are opportunities across sectors, we think the opportunities in technology are attractive. AI in particular stands out to us as a driving force for change. AI is not only revolutionizing industry giants but also unlocking immense opportunities for small companies. Its role as a catalyst for innovation and creation is particularly pronounced for small businesses where resources are constrained but creativity is not.
The way AI allows small dynamic teams to punch above their weight is creating a new playing field for small companies and venture investors. Code creation is getting easier as AI tools continue to get upgraded and AI is also a wonderful assistant in the world of design and marketing. Said another way, AI is shortening the ideation and creation phases of the innovation cycle. Ideas can be built, tweaked, tested, and put on a scalable platform faster than ever before. This significantly increases the importance of operational execution in the venture environment. If everyone’s code is going to work and everyone can create marketing material, then it’s the way you manage the company that will differentiate winners and losers. Investors increasingly need to weigh the quality of the idea against the quality of the management team. Finding companies with both great ideas and the capacity to find the right hires, get patents filed, find contracts, and successfully manage cash flows will become paramount.
