Evolution of Investors in the New Digital Age

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In the last year, we’ve seen the high profile bankruptcies of WeWork and Convoy. Each of these were poster-children “disruptors” over the last ZIRP-infused venture cycles, promising to leverage technology to revolutionize massive “antiquated industries, only to ultimately produce economics inferior to the incumbents they were attempting to disrupt. While there is no gratification in seeing billions of dollars lost, I do think these companies provide a healthy lesson for investors to learn from.

When we started Equal Ventures, I was a fervent believer that the transformation of these “antiquated” industries represented one of the greatest economic opportunities of our lifetime. That belief was squarely rooted in what I was seeing in some of Carlota Perez’s work on prior innovation cycles and reinforced by what I was seeing in the market. That said, we believed this next leg of the innovation cycle would require new capabilities, ones that were more geared toward understanding and underwriting the competitive dynamics of an industry, than the technology risk of a given company. As we examine the aftermath of these companies (and others that we fear are likely to follow in their path), we think it’s important to understand the role of “Investor-market fit” and the capabilities necessary to succeed in these types of companies.

Historically, technical ability was such a scarce skill set that it was the primary driver for venture success. Candidly, this represented a significant disadvantage for someone like myself who was non-technical. Companies were largely led by immensely technical teams (requiring a network of technical talent to source from) and the primary means that you could help a company were by helping them sell to technical customers, recruit technical talent or get them sold to another technology company. Similarly, you needed to deeply understand the application and accessibility of a given technology to be able to invest.

This wasn’t a land for technology novices like myself and I knew it. When I first entered the venture landscape, I knew I wasn’t going to be beating Sequoia on the next great enterprise IT company, so I deliberately focused on vertical software/marketplaces (where the technology was easy enough to understand, but where I felt my understanding of those industries could provide an advantage). Fortunately, as technology has become more mainstream and adaptable to the layman (like myself), we’ve seen an explosion of digital adoption in these sectors creating an opportunity for an investor like myself that likely wasn’t possible a decade ago.

This begs to question, what’s the scarce skill? We’ve discussed how we assess founder capabilities in this new age of entrepreneurship, but what to be said of investor capabilities? As software eats the world around us, we’re not JUST investing in software companies anymore. These new digital entrants require a more nuanced understanding of the operating dynamics of that industry, the specifics of the business model and its sensitivity to macro factors. That’s VERY different from assessing technical risk and requires new skills to evaluate and add value to those founders.

Further complicating this dynamic is the waning persistence of product. Software companies used to have high barriers to entry given the difficulty in developing products. This created a sizable moat (or at the very least a lead) on the competition, enabling companies to generate profits far earlier and for those profits to sustain. That’s no longer the case as advancements in technology have enabled product cycles to move far faster and cheaper than in the past. Whether SaaS or not, the persistence and profitability of revenue is far tighter, making financial efficiency a more important focus than it's ever been before (especially in this market!). Historically, I’d seen investors rely on GMV or revenue multiples and even bragging that it had been several years since they had touched an excel model (despite being Series B/C investors). Today’s investors are quickly learning that level of analysis doesn’t suffice – just because a business is growing, doesn’t make it a great business if it can’t find a long-term path to sincere profits. That’s a different skill set than what many in the venture business are accustomed to and one that is far more in-line with traditional forms of investing.

Therein lies the path ahead. As “software eats the world” and technology goes mainstream, so does the need to evolve the capabilities of venture investors. To date, venture has operated separately from other asset classes. Venture investors were first technologists, where their value was principally derived from their ability to assess the capability and applicability of a given technology intervention. Over the last decade, we have become marketers, where the principal value was driven by your access to opportunities. In each of these cases, the promise of financial fortune IF successful was so strong that core operating performance and the ability to evaluate that were largely ignored. This impacted not just investing, but operating as those values seeped into the companies themselves, eroding financial discipline. 

In this new age, I believe that venture investors need to be, first and foremost, investors. This may seem obvious, and likely is to those who have been in the business beyond this cycle, but core investor skillsets like financial acumen are rarer than I would expect given the amount of capital our industry manages. Over indexing on marketability > math has inhibited a focus on the fundamentals of these businesses and that advice trickles into the companies and their cultures. We’ve seen it with several of the founders that we’re friendly with who were urged by their previous boards to continuously raise capital (i.e., market themselves and their companies), rather than focusing on running a great business. This destroyed a tremendous amount of shareholder value (especially for founders, employees and early investors) when these companies were forced to reckon with the public markets.  

My belief is that the future of investing in this business requires a reversion to the fundamentals - knowing how to build a company capable of producing long-term FCF and being able to evaluate a company for its potential to do so. This may be less exciting, but I think it will drive far greater returns in the long haul as it has in other asset classes. That isn’t to say that investors should abandon the hallmark skill sets that separate VC  from others, but there is a tremendous amount to learn from the practices of other asset classes and believe that the best investors for this next generation of digital investing will bridge these capabilities together.

First and foremost, Equal Ventures is an investment firm. Seed stage investing is where we believe we have the most asymmetric advantage given our capabilities and the competitive landscape, but we frequently partner with those in other asset classes as a means to extend our influence and learn. We feel this is necessary to develop the capabilities necessary to find, evaluate and serve the greatest founders in the industries we cover. I suspect other firms will, too, in the years to come.