Venture Capital Has Lost Its Magic

VC was never meant to grow this big...

The original business model was lean and scrappy. As its name suggests, the goal of venture capital ("VC") was to spread small amounts of capital across many ventures... knowing most would fail, but a few would deliver sizable returns.

VC firms used to focus on fueling innovation and driving growth by owning small stakes in startups. It was the opposite of the private-equity ("PE") strategy of owning whole companies.

However, as with many industries, VCs have faced challenges alongside their success...

The industry has ballooned into a $1.2 trillion giant, more than five times what it was in 2009. As its size has increased far beyond its modest origins, so has its concentration.

And this shift could mean the industry is past its peak already.

The VC landscape is increasingly dominated by massive players...

Firms that operate against the VC textbook – like Andreessen Horowitz, which manages $44 billion in assets – are at the front of the pack.

On the other hand, old-school VC player Benchmark Capital is still raising funds of a similar scale to those it raised in the 2000s. It's focusing on more small investments rather than fewer large investments.

High interest rates have further accelerated this trend, squeezing smaller VC firms that lack the financial resilience of their larger counterparts.

When these smaller firms struggle, or even exit the market, the influence of the big players grows even stronger.

As they gain power, bigger players have started to make bigger bets on bigger ventures... often sidelining riskier early-stage startups.

And since they're making fewer and bigger bets, it's a bigger deal when those bets don't pan out.

While this trend is gaining steam, it has been going on for years...

You might recall SoftBank's (9984.T) disastrous investment in coworking "unicorn" WeWork in the 2010s. It's the perfect example of what happens when VC diverges from its founding principles.

In its quest to go big, SoftBank raised an unprecedented $100 billion... and funneled massive amounts of money into startups.

At first, the SoftBank Vision Fund's prominent investments were hailed as revolutionary. But before long, they became notable for their disappointing outcomes.

The Vision Fund has invested a total of $18.5 billion in WeWork... which was destroyed after failed initial public offering ("IPO") plans exposed numerous financial and cultural issues.

WeWork's valuation plummeted from $47 billion to a mere $8 billion when it went public. The company went bankrupt just a few years later.

SoftBank's investment in Uber Technologies (UBER) didn't go much better. The Vision Fund poured $9.3 billion into the ride-hailing company in 2018, valuing it at roughly $70 billion.

Uber went public a year later at $45 per share. The stock lost nearly 40% of its value within the first 10 months on a public exchange.

By the time SoftBank ditched its Uber shares in 2022, the company was valued at around $42 billion, or roughly $23 per share. SoftBank recorded a huge loss on the investment.

WeWork and Uber should serve as cautionary tales for VC... SoftBank's focus on massive bets meant it prioritized scale over balanced gains. It deviated from VC's original goal of smaller strategic investments.

And that approach hasn't paid off. The Vision Fund posted losses of roughly $20.5 billion and $32 billion, respectively, in 2022 and 2023.

Big VC players either win a little... or lose big...

Or they do their best to avoid risk completely, which leads to smaller returns. That was never supposed to be the goal of this type of investing. VC is supposed to be about fostering agile, innovative startups.

If you're looking to make concentrated bets with big upside potential, the VC space doesn't seem like a great approach anymore. We'd recommend putting some money in microcaps instead. 

Unlike VC, the microcap space hasn't been flooded with cash. It's one of the few places in the market that still can't be.

Most big investors aren't allowed to invest in stocks until they hit a certain size... leaving the very smallest stocks ripe for the picking.

Regards,

Joel Litman
January 13, 2025

P.S. Speaking of microcaps... my team at Microcap Confidential is preparing to share a brand-new recommendation in a diverse industrial distributor backed by strong tailwinds.

This company is a leader in its corner of the market. It has transformed itself over the past 10 years. But investors are still pricing it like a cyclical business with muted returns.

To put it frankly, they're wrong. It all comes down to a crucial competitive advantage... one that the market is completely misunderstanding.

We'll share the full details with subscribers in our January issue, which comes out tomorrow. Subscribe now for 50% off right here.