What Is Venture Capital Now Anyway?

 

"Three decades ago, five men formed a venture capital firm on Sand Hill Road in Silicon Valley with a simple pitch: Small is beautiful.

Their firm, Benchmark Capital, planned to stick to venture capital’s traditional playbook. It would write tiny checks to invest in private technology companies and help them succeed with guidance and connections. It would resist the urge to become bigger over time. Benchmark’s founders even quoted Voltaire: “God is not on the side of the big arsenals, but on the side of those who shoot best.”

Fourteen years later, two entrepreneurs set up shop across the street with a very different plan. They established Andreessen Horowitz, a venture capital firm that would do more of everything — raise more money, do more deals, make more noise and flash more attitude. Ben Horowitz, one of the firm’s founders, called his creation the “anti-Benchmark.”

Since then, Andreessen Horowitz has expanded in every direction. It created funds focused on cryptocurrencies, defense and other tech, managing a total of $44 billion. It became a registered investment adviser, meaning it could own public stocks and cryptocurrencies. It hired 80 investment partners and opened five offices. It publishes eight newsletters and seven podcasts, and has more than 800 portfolio companies. It recently added private wealth management services. There are persistent rumors that it will go public.

Benchmark, on the other hand, has hardly budged. It still has five partners who make investments. This year, it raised a new $425 million fund, which is roughly the same size its funds have been since 2004. Its website is a single landing page.

The gap between the two firms — one clinging to venture capital’s traditional model and the other aggressively not — underscores the profound divergence in the industry that funds and fosters American innovation. As venture capital grew and Sand Hill Road took on the same mythological proportions as Wall Street, many top venture firms followed Andreessen Horowitz’s lead by supersizing. That propelled venture capital out of its longtime finance niche, turning it into a $1.2 trillion juggernaut last year, from $232 billion under management in 2009.

“The venture market has permanently changed,” said Theresa Sorrentino Hajer, the head of venture capital research at Cambridge Associates, an investment firm that has backed venture funds since the late 1970s. “It’s no longer a cottage industry by any stretch.”

Those pushing venture capital’s bigger-is-better strategy said their approach was simply the natural outgrowth of the industry’s decades of success. Apple, Microsoft, Meta, Google and Amazon — five of the world’s most valuable public companies — were all started with the help of venture money.

And as Marc Andreessen, an Andreessen Horowitz founder, predicted in a 2011 post, software ate the world. Tech has infiltrated every industry, creating infinite opportunities for start-up disruption. Now, bigger-is-better supporters say, even more money is needed to solve society’s thorniest problems with innovation. Small funds, they scoff, can back only small ideas.

The growth has prompted frustration and fear about the delicate system of money, talent and ideas that makes Silicon Valley tick. Some worry that venture funds have become too big and the firms too bloated, with not enough good start-ups to invest in, which hurts returns. Smaller firms are struggling to compete against the big funds that can invest more, pay higher prices and more easily absorb losses.

“This is causing fundamental waves in the entire ecosystem,” said Kyle Harrison, an investor at the venture firm Contrary. “I don’t think enough people appreciate the negative aspects.”

Some openly wonder whether there is still a place for boutique partnerships like Benchmark in an age of ever-expanding mega-firms like Andreessen Horowitz. It has raised the question: What even is venture capital anymore?

A $6.7 Million Bet on eBay

The venture playbook was created in the late 1950s when Arthur Rock, an investor, persuaded disgruntled employees of the pioneering chip company Shockley Semiconductor to defect and form their own start-up. He took a minority ownership stake in their new company, Fairchild Semiconductor, and incentivized the employees with shares. Within two years, Fairchild minted a return of 600 times its investment.

Mr. Rock’s success induced others to look for the next new thing. Investment firms clustered among the fruit orchards of Santa Clara County, Calif., on Sand Hill Road. Some, such as Kleiner Perkins Caufield & Byers and Sequoia Capital, became known as kingmakers that provided expertise, connections and, of course, money to help risky start-ups become the next Apple, Microsoft, Xerox and Google.

In 1995, Benchmark opened on Sand Hill Road. Its partners, including Bruce Dunlevie and Andy Rachleff, were a group of energetic men in their 30s and early 40s, most of whom had gone to Stanford Business School and had worked at other venture firms.

They named their firm Benchmark after the industry standard for investment returns — not after themselves, as was common — and decided against having an army of analysts, associates and junior partners. Every partner got equal decision-making power and an equal cut of the profits.

Benchmark quickly catapulted into the industry’s top tier by investing in eBay in 1997. Mr. Dunlevie persuaded Pierre Omidyar, eBay’s founder, to take Benchmark’s $6.7 million investment at a valuation of $20 million, even though it was lower than a competing bid. Within two years, that bet was worth more than $4 billion.

EBay was one of several venture-backed start-ups from that era that went on to become major players in the new internet economy, including PayPal, Amazon and Google. But many other bets failed, and the 2000 dot-com crash tarnished venture capital’s reputation. Founders warned of soulless, bloodsucking “sweater vests” who would kick them out of their own companies to save their investments.

In 2009, Mr. Andreessen, a creator of the Mosaic Web browser and the co-founder of the internet browser company Netscape, and Mr. Horowitz, a fellow Netscape executive, started their venture firm. They had been so put off by their own experiences with venture capitalists at their other company, Opsware, that it inspired them to start their own operation, they said.

Their aim: to treat founders better. In a 2015 interview with The New Yorker, Mr. Horowitz singled out Benchmark and said, “Our design was to not do what they did.”

With a Fortune cover story announcing its first $300 million fund, Andreessen Horowitz immediately stood out as a brash and boisterous presence in an industry that typically stayed behind the scenes. Mr. Andreessen and Mr. Horowitz gave hundreds of media interviews discussing their “founder-friendly” approach, which included hiring teams of professionals to help start-ups with public relations, sales and recruiting.

By 2011, they had amassed $2.7 billion and invested in companies such as Airbnb and Stripe. Mr. Horowitz marveled at his firm’s success in a blog post and bragged about how popular it had become with founders.

Its growing muscle was evident in 2012, when top venture firms, including Benchmark and Sequoia Capital, battled to invest in GitHub, a fast-growing website for software developers. Andreessen Horowitz’s entrepreneurial mind-set was striking, said Tom Preston-Werner, a GitHub founder and its chief executive.

Andreessen Horowitz also made the highest bid, offering to invest an eye-popping $100 million in GitHub at a $750 million valuation.

“They gave us everything we wanted,” said Chris Wanstrath, a GitHub founder. The deal solidified Andreessen Horowitz’s place as an aggressive disrupter. It also paid off: Six years later, GitHub sold to Microsoft for $7.5 billion.

Andreessen Horowitz’s swagger bothered the industry. In a 2013 interview with Mr. Andreessen, Sarah Lacy, a tech journalist, observed that other investors had complained about him.

“You have forever eroded the comfortable margins of venture capital,” she said.

“Aw, that is so sad,” Mr. Andreessen joked. “I feel terrible! How will they afford their third vineyard?”

In a separate interview, Mr. Horowitz called investors who did not want to compete “the crybabies of Silicon Valley.”

Those crybabies responded by copying Andreessen Horowitz. Many hired public relations firms and teams to help start-ups with recruiting, marketing, design and other services. They espoused founder-friendly views on social media. They raised bigger funds.

‘You Make Money When We Make Money’

In contrast, Benchmark mostly stuck to its knitting. Over the years, Mr. Dunlevie and Benchmark’s other founding partners groomed a new generation to take over as they retired, including Bill Gurley, a former equities analyst, and Peter Fenton, an investor who joined in 2006. They made a string of winning bets on Uber, Twitter, Yelp, Zillow and others.

Benchmark’s first eight funds, which were raised and invested from 1995 to 2019, generated returns of more than 7.5 times the money invested, after deducting fees and profits taken by the fund, a person with knowledge of the firm said.

Mr. Gurley, a frequent blogger and commentator, often bemoaned the glut of capital sloshing around the industry. He warned that the easy money was causing start-ups to be reckless and spend too much, with no sign of making a profit or going public.

“This threatens returns for all involved,” he wrote in 2016.

His warnings intensified when outsiders, including SoftBank’s $100 billion Vision Fund and Tiger Global’s fast-moving hedge fund, barreled into start-up investing with hoards of cash. But others, led by Andreessen Horowitz, saw an opportunity to further build their empires by raising larger funds. Venture firms typically charge a two percent annual fee on their funds and take 20 percent of the profits on investments. Bigger funds meant bigger fees.

In 2016, Eric Vishria, a tech entrepreneur who had joined Benchmark, beat out eight other investors to back Cerebras, a chip start-up. Benchmark’s small fund had been a factor in the decision, said Andrew Feldman, Cerebras’s chief executive. That way, he knew the investors were not getting rich on fees; they would profit only if Cerebras succeeded.

“You make money when we make money,” Mr. Feldman said.

In 2019, Andreessen Horowitz registered with the Securities and Exchange Commission so that it could invest beyond private start-ups. The firm promoted its “massive ambition” to become the best investor in everything. At least 19 other venture firms have followed, including Sequoia, General Catalyst and Thrive Capital.

Behind the scenes, limited partners — the pension funds, endowments and wealthy families that invest in venture funds — started worrying that the bigger funds would not produce the same payoffs.

Smaller funds have typically earned higher returns, said Ms. Hajer of Cambridge Associates, but they have also had higher rates of losses. Bigger funds tend to have median returns but fewer losses, meaning they are safer bets with less upside. The ballooning billion-dollar funds could change venture capital’s return profile.

“You don’t invest in V.C. to get median returns,” she said.

Beezer Clarkson, an investor at Sapphire Partners, which invests in venture funds below $1 billion, said her firm sought out funds that could earn at least three times their money.

“It’s harder to see that when the funds get large,” she said.

Is Small Really Beautiful?

By 2020, 16 venture firms had raised funds that were over $1 billion, according to PitchBook, which tracks start-ups, up from just three such funds five years earlier.

That same year, Andreessen Horowitz and Benchmark competed once again — this time to invest in Clubhouse, an audio app that took off during the coronavirus pandemic. Benchmark already knew Paul Davison, Clubhouse’s founder, who had worked as an “entrepreneur-in-residence”— a program for founders to develop new ideas — at the firm.

But Andreessen Horowitz won out after offering to invest in Clubhouse at a valuation of $100 million, roughly 20 percent higher than Benchmark’s offer, a person with knowledge of the deal said. Andreessen Horowitz also pitched its wide range of services, even using its Hollywood connections to wrangle celebrities like the comedian Kevin Hart to join the app. (Forbes earlier reported on details of the Clubhouse investment.)

Benchmark’s partners began asking themselves if their “small is beautiful” model still worked, two people with knowledge of the firm said. They debated the issue when Miles Grimshaw, a young investor, joined Benchmark in 2020 from the New York firm Thrive Capital, where he had made large investments in older start-ups.

Expanding would let Benchmark do bigger deals and back more companies. But it would also mean hiring more staff and managing and mentoring them. The partners would have to schmooze limited partners and create a marketing department. They would have to build a more robust website and attend meetings about what it would look like.

That would all distract from finding the best start-ups to invest in and helping them succeed. Most crucially, Benchmark’s partners worried that a bigger fund would produce worse returns, the people with knowledge of the firm said.

Benchmark decided to stay the course.

“We’re always asking that question,” Mr. Vishria said in a 2023 podcast interview. “You always have to be questioning your assumptions and are you doing the right thing.”

The question came up again a year later during a frenzy to invest in Silicon Valley start-ups. Clubhouse was so hot that it turned down an offer to sell to Twitter for $4 billion, two people familiar with the talks said. Andreessen Horowitz gave the company more money at the same price.

Benchmark’s partners had the same conversation and again decided to stay small, two people said.

The strategy cost it a partner. This year, Mr. Grimshaw returned to Thrive Capital. Soon after, Thrive raised its largest fund of $5 billion. Through a representative, Mr. Grimshaw declined to comment.

Divergent Paths on Artificial Intelligence

Andreessen Horowitz’s investment in Clubhouse turned out to be a dud. In 2022, during a tech downturn, Clubhouse’s popularity waned as people returned to in-person socializing. By 2023, the start-up had laid off half its staff and was reworking its app.

As the downturn worsened, venture capitalists struggled to cash in on their investments. In 2022 and 2023, venture firms invested more money than they returned to their investors, reversing a decade-long streak, according to Cambridge Associates data.

The lack of returns made it harder for younger, smaller venture firms to raise funds. Yet the biggest firms were flush. Andreessen Horowitz amassed a $7.2 billion fund this April. Another firm, Iconiq Capital, raised $5.75 billion in May, while General Catalyst gathered $8 billion in October.

Much of the new money is being earmarked for tech’s latest obsession: artificial intelligence. In that arena, the contrast between the two investment models is stark. Andreessen Horowitz has invested in roughly 86 A.I. companies, including OpenAI. Benchmark, whose five partners do one or two deals a year, has backed around 20.

Their differing strategies were on display with 11x.ai, a hot A.I. sales company. In April, Sarah Tavel, a Benchmark partner, beat out eight firms to lead a $24 million funding into the start-up. A blog post she had written about A.I. and sales had aligned with 11x.ai’s plans, said Hasan Sukkar, the start-up’s co-founder and chief executive.

Even before 11x.ai announced the funding from Benchmark, Andreessen Horowitz swooped in with more money. The Andreessen Horowitz team, which had their own blog post titled the “Death of Salesforce,” led a $50 million funding, increasing 11x.ai’s valuation by nearly four times in just a few months, according to Mr. Sukkar.

It’s too soon to know whether the mega-funds will succeed, since venture funds typically take at least a decade to pay off. In the meantime, industry watchers see a future in which Andreessen Horowitz and its peers follow the private equity giants Blackstone Group and KKR by listing their shares on the public markets.

Andreessen Horowitz has told its limited partners that it does not plan to go public, a person with knowledge of the situation said. But it has made no secret of wanting to build a tech investing empire. Mr. Andreessen has long been inspired by John Pierpont Morgan, the founder of the eponymous finance giant, and for years kept an image of the banker hanging in his office in Menlo Park, Calif., said a person with knowledge of the firm.

Staying small is riskier as the profits have to come from the investments, not the fees. But Benchmark has no intention of changing.

“When it works," Mr. Vishria said, “it’s really magical.”" [1]

1. What Is Venture Capital Now Anyway? Griffith, Erin.  New York Times (Online) New York Times Company. Dec 13, 2024.