Are the VC’s that are providing dedicated mentoring to their portfolio companies the future leaders of the early-stage VC industry?

I recently completed a VC internship at Cocoon Capital in Singapore during my MBA at INSEAD. I have learned a lot during those six months and this experience has clearly changed my views about venture capital and what it takes to be a successful VC in the future.

I want to share my thoughts on what I have learned and how I see the industry changing. I invite comments and discussions on the topic to understand different points of view and experiences.

More Money For Start-Ups — The Battle between Supply and Demand

Over the past decade, investors have massively increased venture finance on a global scale. According to several sources, the annual number of venture capital deals increased 73% in just seven years. The amount of capital invested in those deals surged from USD $52 billion in 2010 to $171 billion in 2017, a gain of 231%. Further analysing data of the past five years, the growth of VCs funding has been more acute in early stage start-ups:

· Seed: deals decreased significantly (-36%), but capital invested increased significantly (+33%)

· Series A: deals decreased moderately (-15%), but capital increased significantly (+36%).

· Series B: deals decreased moderately (-11%), but capital increased significantly (+30%).

· Series C: deals decreased slightly (-8%), but capital invested increased moderately (+13%).

· Series D: deals decreased moderately (-19%), and capital invested decreased slightly (-5%).

It appears the progressive growth of the VC industry forces investors to bet high and specialize in early stages. From my experience the start-ups invested in during their seed stages require more advice and business coaching than later stages, in which VCs focus more on exit strategies.

While there is a lot of literature quantifying investment trends, there is little data that explains how many startups are created and destroyed worldwide over the last decades. Crunchbase (2019), confirms that the number of startups created every year is steadily declining since 2016. On the other hand, both the number of investment deals and the total amount of cash invested into startups has been growing, so the explanation on the startup stagnation does not rely on financing.

From the top 10 causes of startup failure, only one relates to finance, being all the rest related with the business strategy and managerial expertise. According to CBInsights (2019), startups fail mainly because of: No market need (42%); Ran out of cash (29%); Not the right team (23%); Got outcompeted (19%); Pricing / Cost issues (18%); User un-friendly product (17%); Product without a business model (17%); Poor marketing (14%); Ignore customers (14%); and Product mistimed (13%).

The growth of VC investment and the stagnation of startup creation are opposing facts that reveal a new paradigm for the VC model. VCs competitive advantage does not center on their provision of capital alone but offering the management and business advice that entrepreneurs need to succeed.

Mentoring as the Most Important Selling Point of a VC

After analysing early-stage venture capital funds it became apparent that mentoring is becoming an integral part of what VCs offer to the start-ups they fund. While working at Cocoon Capital, a Singapore-based seed stage fund, investing only in B2B deep-tech start-ups, I detected a clear focus on providing the start-ups with extensive support.

Cocoon Capital has 6 full-time employees, with two Partners and 4 Associates. They have raised and deployed two funds and have funded 12 start-ups across both funds. None of their start-ups have defaulted and most have gone for or are approaching Series A funding. Cocoon’s strategy goes beyond supporting companies with tracking performance metrics, growth progression and fundraising; they provide detailed technology and product development, marketing, PR, finance, and accounting expertise. They also have more personal chats with the founders to support them with their personal struggles and fears. Cocoon will in the future run what they call the “Cocoon Academy” consisting of 10 one-hour trainings across the areas mentioned above, which was one of the projects I led. Cocoon sees their returns on the funds as very satisfactory, with the whole team being incentivized to make each start-up a success.

Cocoon has adapted this way of working, calling themselves an active VC as they believe that to be successful as a fund you need to be part of the first 5 funds that a new start-up founder approaches. To be part of the most popular 5, it is important to define a fund brand, and Cocoon prides itself with the amount of support and mentoring it provides to new founders, specifically in the B2B deep-tech space. Often founders in this space are technically brilliant but lack expertise to commercialize their idea. At Cocoon one partner brings technical expertise to the table, the other provides expertise in fundraising, networking, sales, and marketing. The associates have different skill sets and work with the founders within their area of expertise, while also covering daily tasks such as deal sourcing, valuations, and fundraising.

Working with Cocoon can allow founders with no managerial background, but patentable ideas that are difficult to replicate, to become managers. For Cocoon this opens opportunities to be the first choice for founders within this space.

I also have the privilege to be part of the Impact Fund at INSEAD who partnered with Loyal VC in Canada, another early-stage VC. I work as part of the fund’s portfolio management team, which exposed me to a different approach to mentoring. Loyal VC has a database of over 300 mentors that their database of very early stage start-ups can approach. These mentors have a variety of different skillsets and expertise across different industries. I work with some of their portfolio companies to help them even before they get funding above 10K USD, providing mentoring even before Loyal VC decides to make major financial investments.

Even VCs who have been in the venture capital space for longer and have achieved global presence are increasingly branding themselves as VCs which provide mentoring. While researching examples of such VCs it became clear to me that the mentoring provided was more high-level and less involved, but still seen as an integral part of the investment into early-stage start-ups. Now more than ever, many VC’s recognize that there is a need for more dedicated mentoring and industry expertise as start-ups are increasingly seeking out competitors who are offering more time, support, and resources to the start-ups in their funds. A strategy to implement this is to have teams within the VC focused on specific industry investments e.g. Healthcare, Network Effects, Fintech etc.

To summarize, no matter if the VC has an industry-specific focus or invests in a broad range of start-ups and industries, no matter if it is a small, local fund or an established global VC, mentoring the start-ups is part of the value proposition the early-stage VC needs to provide. Mentoring, (providing dedicated time and expertise beyond financial means) start-ups brings higher returns to VCs as it helps founders overcome obstacles, they may otherwise not have been able to manage efficiently.

How do VCs Manage Resource Restrictions if They also Need to Mentor

To better understand the impact of this demand for deeper engagement, I set out to explore the perennial question of resources and sustainability. In a quest to accelerate the growth of their portfolio companies, some VCs are bringing entire teams of startup specialists in-house, but this is costly.

Traditionally, the VC model was focused on creating a few big winners within their portfolio that make up most of their returns (“80% of the wins come from 20% of the deals”). Now there is a trend of VCs typically investing in less risky ventures, of which the majority end up as healthy and stable mid-sized companies.

Since many VCs start following the trend of investing more money in a smaller number of start-ups, it is crucial that a large percentage of them are successful. Hence, this new trend requires strategic involvement from the VC to allow start-ups to reach their full potential, which in turn requires VCs to invest a lot of time working with the start-ups (labor intensive). Operational involvement reduces the time to deal source, so is more engagement with start-ups leading to increased resources thus impacting the number of start-ups a VC can invest in?

It seems to me a bit like a chicken and egg problem — is mentorship required by founders, therefore early-stage VCs can only invest in a smaller amount of companies to manage resources, or do they invest more money in a smaller amount of companies, so need more of these companies to be successful, hence provide more mentoring?

Concluding Thoughts

Early stage investment funds are becoming more and more popular while entrepreneurs are also looking for VCs that can support them beyond offering their deep pockets. Traditionally, mentorship was something provided only by VCs with a smaller investment portfolio, but even larger, global VCs are now finding ways to be more deeply involved. This has led to the emergence of more innovative mentorship models.

However, the resource crunch that comes along with this deeper engagement model means that VCs must reduce their portfolio to be able to provide this support effectively. This makes me wonder two things with regards to the future of larger VCs along with the sustainability of this new model. Will the larger, well-established VCs move more towards trimming down their portfolios or will they find more innovative ways to satisfy this mentorship demand? As for the smaller VCs providing extensive mentorship, are they going down a sustainable route?

While looking for opportunities in the venture capital space in Europe it makes me want to further explore these questions and understand how different VCs are tackling these questions. I would love to hear your thoughts on this topic.