Venture capitalists have been talking about the recent article from The Information entitled The End of Venture Capital As We Know It. Sam Lessin, the author of this article, has some very good points. However, I don't agree with all of his conclusions and would like to discuss why.This will be a fun podcast and because it's Friday, it will be both casual and formal. (It's fun to share a podcast that I did last year with Lessin.Capital explosionLessin points out that venture capitalists used to make risky bets on companies that would eventually fail. The venture model would have failed if it had not been for the higher-than-average investment risks.Venture capitalists made a huge profit by selling their capital to founders. Venture capitalists pay high prices for equity in startups that are high-growth. It is the VCs who get ripped off when a tech company floats. The Wall Street crew is about to take a last lap at the milk saucer.Things changed over time. Instead of spending equity capital on colocation and server racks, founders could use AWS. More people became more familiar with the process of building software and bringing it to market.The traditional way of selling software at a fixed price was overtaken by recurring fees. Software companies' revenues became less like those of video games companies. They were driven by episodic releases, and depend on how the market reacts to the latest version.Software revenues retained their lucrative gross margin profiles, but SaaS made them more reliable and long-lasting. They improved. They were also easier to forecast.Software companies both public and private saw their prices rise.The revolution in software construction and distribution also led to more money pouring into companies that were busy writing code. Startup investing was easier for other capital sources. It is now possible to invest in startups at a later stage of the startup lifecycle, and it is becoming more attractive.Pricing has changed as private tech companies have attracted more capital, partly because they are less risky. Or, to put it another way, investors all over the world now price startups more accurately because they are better able to measure startup risk and opportunity.This is where you can see the problem. If this is the case, then selling capital with huge upsides becomes less appealing. Venture capitalists won't be able to charge as much if there is less risk. With more money to chase deals and less risk, their return profile could change. This might lead to lower prices and higher returns.The result is Lessins' lede. All indicators suggest that non-traditional tech investors, including mutual funds, will invest more in private companies by 2022 than traditional Silicon Valley-style Venture Capitalists.The capital crowding out of parts of finance that were once reserved for high priests of venture means the VCs around the world are often competing for deals with new and more wealthy players.According to Lessin, this means that venture capitalists who grew up investing in software and the internet must either enter the larger pond as a relatively small fish or find another small one.Yes, butLessins' argument is obvious because he himself criticizes it, namely that the topic he is referring to isn't as relevant for seed investing. Lessin says that his arguments have a far lesser impact on seed investing.Yes. Yes, it is the end of venture capital as it exists today. It is not the end for venture capital. Capitalism will continue to thrive if there are still risky investments that VCs can make at the bottom.These factors make later-stage SaaS investing possible that even stupid people can do for a few bucks. This effect is magnified by investing in other areas; biotech startups are not less risky simply because there are public clouds.The Lessin argument is less relevant in seed-stage or earlier investing than in the later stages startup backing. It also matters doubly little when it comes time to invest in non-software companies earlier.Although it is a well-known fact that venture capitalists invest in startups not focused on software, this is still a significant number of investments. While almost every startup requires code, you can still make a lot by building startups, particularly tech startups. However, SaaS investing has not led to a decline in risk when compared with investing in markets.The VCs-aren't-dead idea is less applicable to seed and non-software startups.Is Lessin right to say that the game has changed for software investing at middle and late stages? Yes, it has. But I believe he is wrongly interpreting the idea of private-market software investing as less risky.First, although private-market software investing has a lower risk profile, it is still not zero. Software startups are likely to fail, stall or sell for very little. Are there as many software startups in today's market? Not necessarily, but there are still some.The act of picking is still important. We can wax poetic about how venture capitalists will have to pay higher prices for deals but VCs may retain an advantage in startup selection. This can reduce downsides, but it could also do a lot more.Anshu Sharma, Skyflow and previously of Salesforce and Storm Ventures where I first met him, made an argument earlier this week about this point with which I can sympathize.Sharma believes, and I agree with him, that venture winners get bigger. Remember that once upon a time, a private company worth a billion dollars was rare. They are now built every day. The largest software companies don't have the same value as Microsoft between 1998 and 2019. They are now worth many trillion dollars.Simply put, outliers will be more outlandish in a software market that is more attractive in terms of value creation and risk. Venture capitalists who pick well and go early than they used to can still produce amazing returns. Maybe even more than ever before.These are the things I hear about certain funds in relation to their current performance. I believe that if Lessins' point was true, we would see lower rates of return for top VCs. Based on what I hear, they weren't. (I'm open to corrections if you find any.)Venture capital is changing. Larger funds are becoming more different types of capital managers from the VCs of old. Venture capital is changing as capitalism changes the world. VCs attempted to distinguish themselves from each other by offering services, which was probably through non-venture capital sources. However, this topic was less discussed when The Services Wars began.Even the most fervent Tiger cannot invest in all companies, and not every bet will pay off. It might be that you are better off investing in a smaller fund that has a slower pace of dealmaking. This will allow you to trust fund managers to choose the best allocation of your capital among all other pooled capital. You might get better-than-average returns.The venture model is well-known.
