Even prior to COVID-19, change was afoot in the venture capital industry. Machine learning and algorithms were emerging as new ways to spot winners, and cities like Boston staked out turf as VC hot spots, proving that not all innovation takes place in Silicon Valley.
Since March, however, uncertainty about the coronavirus and its economic consequences has caused a tipping point and a rapid drop in the markets, said senior lecturer at MIT Sloan. “This had at least two effects on venture capital,” he said. “It slowed commitments to VC funds that were in the fundraising stage, and it caused VCs to assess the financial conditions of their portfolio companies.”
Hadzima noted that this is exactly what happened in March 2000 when the internet bubble burst. “The impact then was that companies that had just closed deals were O.K. for the time being, but those that were in the process of trying to raise money got hammered.”
At the 15th MIT Sloan Investment Conference in Cambridge, Mass., (which took place pre-coronavirus), venture capitalists spoke about trends in the VC space to Harvard Business School professor Josh Lerner, a managing partner at Bella Private Markets. Here, we look at those insights, as well as how the market has changed amid COVID-19.
Algorithms can do a lot (but they can’t do it all)
Machine learning has been touted as the next big thing in VC to help spot a winner. But while an algorithm can process hundreds of data points to make recommendations on a company’s viability, there’s still a need for a venture capitalist’s intuition.
“Everybody refers to venture capital as pattern-matching, which is very much true, but you’re also doing anti-pattern matching,” said Blake Bartlett, a partner at OpenView, a Boston-based venture capital firm. “Venture capital returns largely come from backing single outlier companies that often look like the anti-pattern in their early stages.”
That said, identifying uniqueness on its own isn’t enough. “An algorithm can indeed detect anti-patterns or anomalies,” Bartlett said, “but it may fail to assess the more qualitative aspects of venture capital judgment, like determining if the anti-pattern is also novel and logically sound.”
Not all themes are worth chasing
Speaking of picking winners, we’ve all heard about “the sharing economy” and how it’s benefited companies such as Airbnb and Uber. Sometimes, themes like these are useful for identifying what will catch on, but by the time they go mainstream, it’s probably too late to hop on the bandwagon.
“Throughout my career, I’m reminded of the fact that the minute a theme has been announced in the press, it’s too late,” said David Frankel, managing partner and co-founder of Founder Collective, a Massachusetts-based seed-stage fund. “So my advice would be: Don’t chase the themes.”
Seed investing is a class all its own
Before the coronavirus, seed funding grew so popular that it emerged as its own class, causing plenty of firms, like Founder Collective, to specialize solely in this early stage of venture capital funding for startups.
“I think that every venture fund for a brief moment in time decided they were seed investors because it seemed sexier and more fun, but at the end of the day, seed investing is very different from series A investing, and it is very different from late stage investing — they take different disciplines,” said David Hornik, a general partner at August Capital, a technology-focused fund based in Menlo Park, California. “I do think that the fact that we have all these seed funds is great news because those folks can focus their attention on getting things started.”
Boston is a hotspot for venture capital
Move over, San Francisco. VCs are snapping up plenty of investment opportunities in Boston, which is ripe with entrepreneurial talent, especially in tech.
“We’ve seen many billion-dollar companies emerge here in recent years,” said Sarah Hodges, a partner at Pillar, an early-stage venture capital fund in Boston. “Ninety percent of our portfolio is here in town. The new technologies of this decade are growing directly out of the ecosystem in Boston, many with roots at MIT and Harvard.”
Venture capital is a long game
It can take years for a venture capitalist to see an investment through, especially in early-stage investing. For successful companies, that timeframe usually ranges between 10 and 15 years, said Larry Bohn, a managing director at General Catalyst.
“While the average time to exit is eight years, the early exits are often companies that fail,” he said. “The successful companies take a meaningfully longer time to grow and be successful. The thing about this business is it’s sort of like watching a long movie, and you can’t get out of your seat. You have to have a lot of patience and the ability to ride the ups and downs."
With the industry now in the thick of COVID-19, Bohn acknowledged that “the mood is pretty gloomy” as companies are cutting costs to survive in an uncertain market. “It’s been mind-boggling how fast things have pivoted from a focus on growth to one of profitability and survival,” he said.