What’s Going on with Early-Stage Founders?
A few weeks ago, I shared my thoughts on what’s been happening recently in the early-stage investment market, which is more bifurcated than it’s ever been. In short, I believe that we’re currently witnessing both a realignment of the investment strategies of many early-stage VCs and a fundamental shift in how the best founders raise capital. In my previous post, I dug into the first part of that statement. This week, I’m going to dig into how and why top founders are changing their approach to fundraising and the impact it’s having on the venture capital industry.
To set the context, let’s start with an overview of a fundamental shift that’s currently taking place in venture capital.
Venture Capital is Dead!
Right now, there are an incredible number of hot takes about venture capital. Try searching “venture capital is dead” and you’ll see pages upon pages of blogs and opinion pieces on why VC is dead (or, at least, VC as we know it). Read a little further and you’ll quickly realize that the majority of these takes were written by people who provide alternative products to venture capital or who have a philosophical opposition to the VC model. Add to that a handful of well-meaning but inaccurate posts written without the benefit of knowing the numbers behind-the-scenes (I promise that a handful of multi-billion dollar funds registering as RIAs does not portend the death of venture capital 😉), and you’re forgiven for believing that, this time, VC really is dead.
I’m sorry to say, VC is not dead. But it is definitely changing.
The Bifurcation of Venture Capital
The past decade saw the emergence of VC “megafunds”, as leading firms raised larger and larger funds in order to expand their capabilities and competitive advantages. That trend went into overdrive following the ZIRP crash, with institutional LPs desperate for safety as exits dried up.
Last year, 9 firms raised half of all VC capital in the US (more than $35 billion). The top 30 firms accounted for 75% of all capital raised by US VCs:
At the other end of the spectrum, emerging funds — in particular, those less than $50M in size — saw an increase in capital raised. At the extreme end of this trend are microfunds — funds less than $10M in size — which accounted for 42% of the funds closed in 2024.
In contrast to the perceived safety of megafunds, LPs tend to invest in sub-$50M funds because of the combination of (1) a focused thesis and (2) a disproportionate potential to generate outsized returns. As one longtime investor put it,
“There are a dozen ways to 10x a $30M fund; there’s only one way to 10x a $3B fund.”
Rex Woodbury describes these two categories as “artisans” and “scaled asset managers”:
“Artisans focus on people; they invest capital, sure, but their value really shines in hands-on partnership…Asset managers are more about the money—their form of venture is less about craft than about putting dollars to work.”
The Tail Wagging the Dog
Ultimately, LP investment dollars follow returns. And returns come from the ability of VCs to successfully invest in the best founders and companies.
So while it’s interesting to talk about the bifurcation of venture capital in terms of LP dollars raised, this is actually a lagging indicator of a behavioral shift on the part of founders.
Everett Randle of Kleiner Perkins predicted this shift back in 2021. Specifically, he foresaw the “middle squeeze” that we’re currently seeing in venture as akin to what happened in retail during the decades prior. Since the turn of the millennia, consumers have increasingly chosen luxury brands (e.g. Tiffany) and mass-market retailers (e.g. Walmart) over the middle ground. Everett noted,
“The most exposed and vulnerable will be funds stuck in the “middle”. When choosing between capital providers, sometimes founders will want the $12 Amazon Prime 1-day-shipping Carhartt T-Shirt, sometimes they’ll want the $1,500 Gucci Cardigan, but very rarely will they want the $22 J.C. Penney Hoodie. You really, really don’t want to be the VC version of J.C. Penney.”
Today, Founders Really Do Have the Power
There was a time not so long ago when the power disparity between founders and VCs was so extreme that investors held virtually all the chips. In the early days of Aster Data, we needed to raise $1M in order to buy the physical servers that we needed to develop and test our software on. There was no “bootstrapping” for enterprise software companies in those days. Either we raised venture capital or the company would not exist.
Fast forward 20 years later and the tables have turned, primarily as the result of three major shifts:
Reduced Costs - AWS drastically reduced the overhead costs of developing and deploying software. The resultant cloud / SaaS offerings drastically reduced the overhead costs of building a company. The combination meant less capital required to get many new startups off the ground. The recent innovations in AI have put this dynamic on steroids.
Shorter Time to Revenue - Not only have technical advancements reduced the cost of bringing software products to market, they’ve also reduced the time to initial revenue. The potential for global distribution from day one has fundamentally changed the revenue trajectories for many startups.
More Funding Options - In parallel with these fundamental changes in company formation, we’ve seen an explosion in funding options for startup founders. The emergence of microfunds, operator VCs, crowdfunding and a proliferation of angel investors — combined with an increased willingness by VCs to invest globally — has led to far more capital options for founders than ever before.
Which brings us back to the bifurcation of venture capital…
How Founders Today Think about Venture Capital
What we’re seeing with early-stage founders today is the manifestation of the shift Everett Randle warned about back in 2021. With more options (and, thus, more power) than ever before, the world’s best founders are increasingly rejecting the “VC version of J.C. Penney.” Some are rejecting venture capital outright. Others are taking the “seedstrapping” approach to fundraising, wherein they raise a single round to get things off the ground and strive for profitable growth from then on. Those who do seek out external funding are overwhelmingly choosing between one of two options:
Scaled Asset Managers: Megafunds, with their globally-recognized brands, deep pockets and comprehensive resources
Artisans: Emerging Managers, with their focused specializations, narrow investment theses, and clearly-defined value-adds
In the past three years, this massive shift has contributed to more than 2,000 VC firms globally shuttering their doors.
If you’re surprised by the scale of the numbers above, it’s because the U.S. tech media (which is the source of much of the world’s news on all things tech), really hasn’t covered this. And that’s because such seismic shifts have happened there before. The first such shift happened in the early-2000s, after the dot-com bubble burst. The second occurred after the financial crisis of 2008. In both cases, a significant percentage of under-performing VC firms failed, only to be replaced by a new generation of emerging firms.
Case-in-point: megafund a16z was founded in 2009.
But in the rest of the world, this is really the first time that domestic venture capital industries have experienced an existential crisis of this magnitude. Up until now, they’ve mostly been sheltered by virtue of:
A hesitancy by U.S. VCs to invest internationally
A hesitancy by local founders to seek capital internationally
In other words, until recently, many VCs around the world benefited from a local advantage.
But if our earlier retail analogy is anything to go by, that local advantage is about to disappear forever.
In the consumer bifurcation of the past two decades (towards focused, direct-to-consumer brands and cheaper, mass-market retailers), one of the biggest losers was generic local retailers who depended on a local advantage but offered little more than higher prices to their shoppers. It turned out that, when presented with options, the vast majority of consumers simply weren’t willing to pay a higher price solely to subsidize a local retailer.
The same is proving true when it comes to venture capital.
Today’s founders — empowered by the realization that they hold more power than ever before — are increasingly unwilling to accept a lower-quality product from investors simply because those investors are local. And many mid-sized VCs around the world are waking up to the reality that they may, in fact, be the J.C. Penney of VC.
Before I go any further, I want to be clear: I’m not suggesting that there is zero value in local venture capital. Quite the contrary.
I believe that a strong domestic VC industry — especially at the early stages — is an essential component of any tech ecosystem. Despite all of the technological and cultural shifts that are happening, the vast majority of Pre-Seed and Seed deals are led by local investors. Which means that the availability of strong local early-stage funding options is critical to the success of startups around the world.
But once you’ve got a product and/or some early traction, all bets are off. At the later stages (and, increasingly, at Pre-Seed and Seed for top founders), the competition for the privilege of investing in their companies is now global.
Jack Newton, the intensely patriotic CEO and Founder of Canadian unicorn Clio, recently highlighted this perspective, noting that,
“Though it might be nice for Canadian investors to reap the returns of domestic companies, the creation of jobs and homegrown talent is the most important thing,”
So how are VCs around the world reacting? Surprisingly similar to how local retailers did twenty year ago when threatened by “big box” retailers. In a striking parallel to local business associations of the past, venture capital associations around the world are increasingly trying to tie the survival of their members to that of the ecosystems in which they operate.
For example, outgoing CVCA president Kim Furlong recently inferred that a drop in deployment by Canadian VCs in Q1, “…threatens the innovation economy we’ve worked hard to build.” But the data doesn’t support her assertion. While funding from Canadian VCs into Canadian startups fell in Q1, overall funding in Canadian startups actually rose according to PitchBook, with U.S. investors participating in 80 per cent of Canadian venture capital investments that quarter.
Adapt, Evolve, Compete or Die
Today’s founders are emboldened by choice and, just as with consumers of the past, there’s no going back to mediocrity for them. As Everett Randle predicted, the most exposed and vulnerable funds are those currently stuck in the “middle” — surrounded by heavily-resourced megafunds on one side and a growing number of laser-focused emerging funds on the other. That leaves such VCs with the choice first posed by famed hedge fund manager Paul Tudor James: “adapt, evolve, compete or die.”
Thankfully, there are many paths forward for fund managers to take. They can reorient around a more focused thesis, as Canadian firm Two Small Fish and U.S. firm Susa Ventures did with deep tech (the latter via spinout fund Humba Ventures). They can develop compelling platform offerings, as many U.S. VCs did post-2008. Or they can even double down on a geographic advantage, demonstrating to local founders that they understand their needs better than anyone, as Toronto-based Golden Ventures recently did in spearheading the inaugural Toronto Tech Week.
In the coming years, we will see a number of prominent VC firms reorient around new strategies as this shift progresses. We will also see many shutter their doors as they fail to react to the changing landscape. But rest assured, ecosystems around the world will survive and thrive. With more and more new funds being created, founders will continue to have plenty of options even if J.C. Penney, Kmart or Hudson’s Bay close their doors.
