All the things wrong with venture capital are about to get even worse.
The truth, the rant, and the fantasy for 2025
As we enter 2025, everyone I know is complaining about the venture capital ecosystem in Silicon Valley.
- VC’s are saying “This is a hard business! I have no idea what the next Uber or Airbnb will be, but I’m sure it will have the letters AI in it!”.
- Limited Partners (who provide the capital to the VC’s) are saying “Your fund results are terrible — a blind pig with an index fund could do better!”.
- Startup Founders are saying “I have an incredibly awesome startup but all the stoopid venture capitalists just aren’t interested!”.
- Social Entrepreneurs are saying “The VC’s just don’t understand that I’m changing the world and I’m totally worthy of their grubby money!”
They are all absolutely right, and yet they are all objectively wrong.
The Truth
The truth is that Venture Capital has always been a terrible business. There are more than three thousand venture capital firms in the United States, yet only a tiny few are successful. In fact, 95% of the entire industry’s returns are generated by less than 5% of the firms.
So if you wake up tomorrow morning with an extra $100 million to invest somewhere, you’d probably be better off putting it into your nephew’s S&P 500 index fund than putting it into an average venture capital fund.
Successful VC’s get heralded as modern geniuses, but they’ve used the exact same brain-dead simple model for many decades now. They raise funds on a 2-and-20 basis, they deploy the capital by doing simple equity financings in startups, and then they sit and wait for the startups to either get acquired or have an IPO. Their model hasn’t changed in a half a century.
But what definitely has changed is the size of the funds — Sequoia’s first fund in 1974 was $3 million; the most recent fund raised by Andreessen Horowitz is $7.2 Billion. This has led to one of the most broken things about VC today: managing billion-dollar funds means you can only invest in multi-billion-dollar opportunities. Their model is so inefficient (nine losses for every win) that every investment has to have a $10B potential in order to get a decent overall return for the fund.
The performance of a VC fund is measured by one simple number: Distributions to Paid In Capital (DPI). It answers the only question that matters to investors: Over the course of 10 years, how much was paid back out of the fund as a multiple of what was paid in? Most VC firms will tell you that they shoot for 3x (so if you put a million dollars into their VC fund you’ll end up getting three million back over 10 years). Yet if you look at PitchBook data on 1,186 VC funds, just 181 of them (15.3%) have DPI of 2x or higher.
Just so you can grok how bad that is, the average S&P 500 index fund has returned 3.3x over the past 10 years. Did I mention what a terrible business venture capital is?
The Current State of Play
Peak VC happened in 2023. That was the year that, for the very first time, aggregate money flowing into VC funds exceeded returns. The ZIRP-induced venture capital party of 2010–22 came to an icy end at approximately the same time the pandemic did.
Since then, the compression I outlined above has become even more pronounced: Of all new capital raised by VC firms in 2024 (approx $76B), 75% of it was raised by just 30 firms. Nine of them took in half of all new capital raised. One firm, Andreessen Horowitz, brought in over 11% of all capital raised in 2024. Read those numbers again, because they are pretty stunning.
Meanwhile, there have been basically no returns to investors on VC funds raised since 2021 and those Limited Partners are getting antsy.
Here’s my essential point of this entire post: All the things wrong with venture capital are about to get even worse. The already bunched-up money is getting even more bunched-up into a few large firms using an old fashioned model. All the other VC firms are getting squeezed out and will have difficulty raising new funds. Entrepreneurs will continue to find that most startups just don’t fit the venture capital model at all.
The Rant
As I’ve ranted before, it’s ridiculous that a nice, solid, well-run company with the potential to get to $50M/year cannot get funded on Sand Hill Road today. Most of us would be very happy to have a $50M/year profitable company, but for venture capitalists the value of equity in a company like that just isn’t going to move the needle for their billion dollar fund.
So every day venture capitalists pass on investing in perfectly good companies, which is a ridiculous result of their tired model.
I’ve also ranted that some of the rest of us have been complicit in fostering the VC Unicorn mentality. Every startup accelerator dedicates at least half the program to how to get venture capital. Even accelerators focused on social ventures do this, which is especially ridiculous. I’ve heard social venture thought leaders say that we need to “teach” the venture capitalists about how important social ventures are, which shows remarkable cluelessness.
Actually, we’d be doing entrepreneurs a big favor if startup accelerators focused on teaching founders how to grow a successful business without raising venture capital. Those skills would form the foundation of a far more valuable curriculum.
The fact is that 95% of all the successful businesses out there have never raised a single nickel of venture capital. We should spend more time talking about them and celebrating those companies. How did Mailchimp, Zapier, and Farmgirl Flowers succeed wildly without venture capital? That should be the curriculum of every startup accelerator program.
Here’s the thing: for startups, the purpose of venture capital is to be able to grow at an unnatural pace. That’s great for a few companies like Airbnb and Uber, where growing at an unnatural pace was essential to their success. But the vast majority of startups would be better off raising a little seed capital and then growing at an organic pace, using traditional sources of expansion capital when required.
Yet too many startup founders sit around dreaming of venture capital, and complaining that it’s not flowing their way.
The Fantasy
Here’s my fantasy, entering 2025: Everyone needs to stop obsessing about venture capital and start thinking of all the great ways that startups can be financed and investors can make money.
There are more great entrepreneurs than ever before, working hard all over the world to solve problems and create opportunity. But for most of these entrepreneurs, traditional venture capital is just not a fit. Get over it.
Meanwhile, half the money that flows into venture capital funds will end up with disappointing returns. That’s something like $40 billion/year currently flowing into VC funds but coming back as mediocre results.
So why not create new funds with investment structures that deliver better returns while also better meeting the needs of all the great startups that aren’t a fit for venture capital?
Yes, I know it’s easier said than done.
But Beneficial Returns is doing it, successfully offering debt to social enterprises. Republic is doing it, with new ways for startups and investors to connect and transact. Royalty financing is increasingly being used in life sciences. Lighter Capital is offering non-dilutive revenue-based financing to startups. There are many others.
To be a sustainable ecosystem, capital needs to make a round trip from the fund to the company then back into the fund, at a profit. There are four ways for that capital to come back with a profit: (1) Equity gets sold; (2) Earnings distributed to equity holders; (3) Interest on debt; (4) Royalty/Revenue Share.
Four possible ways, and the venture capital industry uses exactly one of those. We need some smart people to put together new funds and investment structures that use additional ways to create a sustainable capital ecosystem that supports a broader range of entrepreneurs while delivering satisfying returns to investors.
That’s my wish for 2025. Everyone needs to stop obsessing about venture capital and start thinking of all the great ways that startups can be financed and investors can make money.
This was adapted from my weekly missive for entrepreneurs, investors, and innovators.
Notes on data sources:
Most of the data I’ve used in this piece can be found on PitchBook, Crunchbase, and Carta.
Here are some of the specific articles I pulled data from:
https://pitchbook.com/news/articles/us-vc-fundraising-concentration-andreessen-horowitz
https://martinkrag.substack.com/p/venture-capital-is-a-mean-business
https://carta.com/data/recent-vc-fund-performance-q3-2024/
Sam Lessin on how VC’s are the lazy JV team.
