If you still follow me on Twitter (sorry if you still do), you may have noticed that I’ve been working out some thoughts related to the impact of how much money is not only in the Bay Area today, but how much more may come in. Yes, I know that global interest rates are low and that some unforeseen event could make people pull back, but the scale of money looking for direct and indirect investment is so large, it may take a few huge events to rattle those markets to the point of clawback.
If there’s a lot of money here, then, what are the various motivations of those money sources? And, how do those motivations potentially affect and/or alter the scope of what startup companies and early-stage investors have traditionally done?
Financial Motivations: When the investor, like traditional VC firms, are looking purely to maximize the financial return. At the end of the day, VC firms are judged some standardized fund metrics like IRR, distributed cash, and so on. As a variant, we also have investors with “Direct Motivations:” Some folks who traditionally didn’t have access directly to companies would use VC firms to help gain access, to help them attract deals and pick good deals, and then manage those investments to exit. Over the past few years, many of these investors who were once indirect are becoming increasingly more direct, bypassing the fees and gating structures of VC firms to invest right on the cap table of a startup. These are still financially-motivated investors.
Strategic Motivations: Some investors, like corporations with cash on their balance sheets, are looking for earlier access to cool companies, teams, and technologies — I have seen them starting to co-invest as early as the Series A (alongside a VC firm they know or recognize) and even in some cases leading what has traditionally been a Series A round, in terms of size. Usually in these cases, the financially-motivated investors (above) have passed on the opportunity, as these rounds can at times contractually restrict the startup in some way.
Deal Access Motivations: As I mentioned those with “Direct Motivations” above, some of those money sources are investing in new, smaller funds to pick off deal flow before it gets to the traditional financially-motivated VC firms, many of which have grown over time to the point where they need larger outcomes. Some of these smaller funds (under $50M) have investors (LPs) which prioritize “turning over lots of cards” in order to discover deals earlier in the company lifecycle and potentially pick off the next winner.
Educational Motivations: Like those investors who are strategically-motivated, some are interested simply in learning more about a certain industry (perhaps focusing on a vertical fund in a certain industry) or a specific geography — for instance, an LP from overseas who wants to learn more about the Seattle startup ecosystem, or the space startup ecosystem, or maybe the space startup ecosystem in Seattle.
Diversification Motivations: Outside the U.S., other countries with growing or shifting economies may have an incentive to seek out diversification (such as currency diversification), where that local money is looking for alpha outside its own borders.
These myriad motivations add up to help create an environment in the Bay Area that’s different from the past. Not all money sources are motivated by pure financial return — depending on the source, they’re looking for a different kind of alpha, for deal flow, for earlier access, for talent, for companies to acquire (but not at VC prices), to learn more an industry or ecosystem, or to diversify their cash positions. And these myriad motivations of the money sources may change what their managers elect to invest in, how often they invest, and so forth. I need to think more on this topic and its ramifications, but wanted to share in case others had an opinion. I’d be interested to hear your take. Thank you.