Venture Goes Multi-Product

The capital markets for private tech companies are sorely outdated. Expect this to change as today’s venture giants seize an opportunity to become multi-strategy institutional asset managers.

So much of the discourse around the challenges facing VCs focuses on the dynamic of “too much capital chasing too few deals” and the need for consolidation. Unfortunately, it misses the fact that the problem isn’t simply one of oversupply, nor one that consolidation alone can fix.

Actually fixing the challenges requires acknowledging that they run much deeper: the entire capital markets infrastructure for private tech companies is completely outdated against the backdrop of a tech ecosystem that has evolved over the last two decades. This evolution requires a fresh attitude around capitalizing growth-stage tech companies – and presents a huge opportunity for firms selling new products to them.

Venture capital: an oversupplied commodity product

Consider how investors generate alpha. Unless you can reliably “pick” better than your peers – difficult to do and essentially impossible to do consistently – generating alpha is a function of (i) a fundamentally different product (ii) with some kind of structural advantage (iii) to a demand pool underserved by other financiers.

When venture was a nascent asset class, VCs actually did this, offering expensive risk capital to smart young people with bold ideas that no bank would underwrite.

Not today. Venture has become a commodity product, which has eroded alpha generation opportunities throughout the industry. Every VC sells the same product – convertible preferred equity with a 1x liquidation preference – to a pool of founders properly served (over-served, really) by the market.¹ The dated fund life is not a construct that offers investors a structural advantage like float (low cost) or a balance sheet (permanence). Some firms have built superior brands, developed a genuinely better picking muscle around making truly contrarian bets, or married excellent access with a highly concentrated strategy. But firms playing the right game are few and far between. Most are copy-paste versions of each other promising the same thing – “we back visionary founders building generational companies in massive markets” – and chasing the same hot deals.

Most VCs push an over-supplied commodity product on companies and charge exorbitant fees to do so. It’s a not-so-disguised, abusive wealth transfer mechanism: there’s no alpha in doing this, and they can’t and won’t generated outsized returns for anyone but themselves.

Existing products are poor instruments to capitalize most risks

The tech ecosystem has evolved – companies today just aren’t as risky as they once were

Ironically, even though VCs trip over themselves to sell a singular product, it’s not even a good fit for most companies and doesn’t appropriately match the risk profile of the asset class.

Silicon Valley (especially in software) is much more mature than it was two decades ago. Every market is picked over and ultra-competitive. There are many self-reinforcing reasons for the explosion in early-stage startup formation: lax monetary policy that pushed allocators further out on the risk curve, induced demand, the “YC-ification” of startup culture, the GFC and relative changes in prestige between Wall Street and Silicon Valley, etc.

More than anything, though, building companies simply became easier – and less risky. The early wave of SaaS companies faced major risks:

• Technical: can we build web-based workflow tools and deliver them via the cloud?

• Market: will anyone want this? Is there enough customer spend to support a big outcome?

• Business model: are customers ready to think about software as opex instead of an up-front investment?

Cloud computing, plentiful dev tools, widespread playbooks, and remote talent meaningfully de-risked the company-building journey – and the number of companies soared. AI only accelerates this dynamic as the cost of writing code declines and software becomes even easier to build.

Of course, startups today face plenty of risks. But many fall prey to incrementalism: how can we make this existing solution slightly better? And, critically, even truly innovative companies very quickly enter a phase in their lifecycle dominated by GTM execution risk. By the time they become a “growth-stage” or “pre-IPO” company rather than an “early-stage startup,” their growth is largely actuarial: Hire X, Spend Y, and generate Revenue Z.

Doing this is hard, but there are far fewer unknowns today than there were before. How to transition from PLG to sales-led growth, navigate complex enterprise sales, establish channel partnerships, manage co-sell relationships, hire / ramp / compensate sellers, etc. all have codified playbooks. GTM execution isn’t riskless (every company would become enormous if it were), and the statistical relationship between S&M spend and growth can be noisy. Still, it’s a much lower-risk exercise than it was in the nascent days of the software ecosystem.

Preferred stock is far too expensive for many companies’ risk profile

Consider the abstraction of the average growth-stage software company: (i) a set of workflows or agents (ii) built atop a data asset (iii) with recurring revenue contracts and (iv) a GTM “machine.”

Silicon Valley dogma tell us that this is a risky, asset-light company – and that expensive preferred stock is the only appropriate product to capitalize it. I see a company with three relatively low-risk assets. Two are legible (the data asset and recurring revenue contracts) while one is less well-defined (the GTM machine).

How much risk does a business that looks like this really face? Is preferred stock an appropriate instrument to finance those risks, or to finance those data / revenue / GTM execution assets?

Consider that traditional venture capital is essentially perpetual preferred stock that pays no dividend and that VCs can convert into shares of common stock if they wish. Given how difficult it is to reason about the fundamental value of a fast-growing, unprofitable company with a small number of employees and some ideas and customer contracts, the instrument is in many ways like an OTM, long-dated call option on a highly volatile underlying asset. When a company “works,” it acts like common stock, and VCs retain a permanent ownership stake in the company; when a business fails or has a modest outcome – as most do – it acts like senior unsecured debt, with VCs entitled to recoup their invested capital in a liquidity event before common shareholders receive anything.²

This construct makes sense for both VCs and early-stage companies attacking significant technical, market, or business model risks. VCs “get paid” to take the risk, knowing that they’ll have either a permanent stake in something that could be very large or, at the very least, a significant degree of downside protection. And while founders are giving up a meaningful stake in their business, they have discretionary resources available to deploy against high levels of risk that no bank would ever finance. It’s expensive, but it ought to be: VCs taking big risks ought to reap the rewards. For that same reason, the steep price makes it a terrible instrument to finance lower-risk initiatives.

What about venture debt?

The primary alternative to preferred stock is venture debt: senior, secured loans (collateralized by a company’s assets or equity) that often include some kind of warrant coverage.

Venture debt never made much sense to me for lenders. Early-stage companies are terrible credits, so lenders are basically underwriting the quality of their equity investors; this works in a robust macroenvironment but can get ugly quickly in a downturn. And needing to recycle capital into new investments every time debt is refinanced puts constant pressure on deal flow generation.

It’s consensus (correctly so, in my view) that venture debt makes little sense for companies too. Debt creates an enormous duration mismatch challenge for them: ultra-long-dated potential future cash flows don’t stack up well against debt with mandatory short-term repayment. It also distorts their behavior, shifting their focus from investing in high-potential R&D and customer acquisition to low-value debt service. And it can wipe companies out overnight. Companies sacrificing profitability to take huge risks should not be raising short-term, high-interest rate debt laden with restrictive covenants. And those not taking meaningful risks need new solutions.

Busted markets are downstream of busted attitudes

Concretely: new companies executing against their risk-taking hypothesis should use expensive equity, fund actuarial growth spending and / or capitalize other legible assets with lower-cost products as they scale, and tap the equity markets intermittently if they need to take another risky big swing (like funding product development and GTM initiatives for an uncertain “second act”).

It’s not like other solutions beyond preferred stock don’t exist. Blackstone has done some notable ABS deals, fintechs like Brex / Pipe / Capchase provide non-dilutive capital, and firms like Treville and Architect offer creative solutions for their tech clients. Among traditional venture firms, GC has taken a clear lead, going multi-strategy already and pioneering a new form of GTM-focused financing with their Customer Value Fund.

Why aren’t solutions like these as popular as they should be, particularly given the amount of investor capital they can absorb? Unfortunately, even though today’s market paradigm is busted, most companies simply don’t care. Alternative capital providers are often “pushing” their solutions onto companies rather than feeling market “pull.” This may be the one PMF problem where customers are to blame.

It’s an attitude problem: Silicon Valley’s reflexive aversion to anything that sounds even vaguely like it came from Wall Street. Building 0 → 1 requires technical, product, and GTM chops. Fundraising skills are critical too, but financial sophistication is not, and founders look down upon finance types. This dynamic was accentuated during the ZIRP period, which obscured the need for founders to think critically about capital structure: why get creative when VCs were giving money away for free?

It's tempting for founders to believe that finance doesn’t matter. But ignoring finance and applying a one-size-fits-all approach to fundraising – and ignoring how a company’s character and risk posture change over time – is to their own detriment. This mostly obviously manifests in the artificially high cost of capital (and excess dilution) that founders have imposed on themselves and their shareholders. Perhaps more importantly, the artificially high cost of capital warps operating decisions by imposing growth expectations that their companies often can’t support: equity investors underwrite growth incompatible with the (otherwise healthy) rate of return on the marginal dollar of GTM spend. It’s value-destructive capital allocation that leads to bloat, lack of product and GTM focus, and busted unit economics.

Beyond equity

The self-reinforcing attitudes around financial sophistication in Silicon Valley won’t change quickly, but investors in growth-stage companies and those companies themselves have incentives to adopt a new mentality as the old market paradigm becomes obviously inadequate to both. Expect attitudes to change:

1. Don’t think too critically about their capital structure → an under-optimized balance sheet both needlessly dilutes shareholders and creates unnecessary pressures that warp decision-making.

2. A one-size-fits-all approach to financing companies makes sense → how you capitalize a business depends on its risk-reward profile and fundamental character, both of which evolve over time.

3. Venture-backed companies are too risky to support anything other than equity → even a “risky” business can contain assets that aren’t risky at all, and financing those assets can look very different from financing the corporate itself.

4. Structure must be avoided → structure is simply a tool to create win-win situations by bridging the gap between what investors need and companies want.

Of course, product and GTM chops will remain critical (and paramount). But for the first time, founders and investors alike will be rewarded for financial sophistication and creativity. And the entire ecosystem will be better for it: for founders (lower cost of capital, fewer warped incentives), investors (expanded investment opportunities, less commodification), and consumers (more and better company formation).

The firms most likely to “fill the gap” in the capital markets ecosystem are those who have already begun their institutionalization. Firms like a16z, GC, and Thrive have raised huge funds, offer “venture beta” to their LPs, win allocations in competitive rounds due to their structural cost of capital advantage over smaller firms, and even expanded beyond the traditional venture strategy.

They’ll carve the same path that PE megafunds did, expanding outside their core, large-cap buyout strategy into new asset classes like private credit, real estate, infrastructure, and middle-market buyout. Instead of offering one product – preferred equity – they’ll become the multi-strategy asset managers of the private tech ecosystem, offering a wide array of products to companies and different vehicles to LPs.

ARR financing

ARR financing was buzzy in 2021 but never became widespread – the main providers struggled with their own cost of capital and adverse selection problems. But most companies ought to be utilizing it to a far greater extent.

ARR is a valuable asset when a vendor’s value prop is clear, customers are sticky, and gross margins are high – famously “better than first-lien debt,” even. Amidst all the other risks and uncertainties that a venture-backed software company faces, its recurring revenue contracts are predictable and relatively “safe.”

Companies can unlock low-cost capital by selling ARR receivables, investing the proceeds into additional growth or R&D, and even financing the incremental revenue they generate as a result: a rinse-and-repeat motion with a significantly lower cost than raising convertible stock.

When private investors take a stake in a software company, they’re implicitly betting that the business will grow ARR enough to offset the multiple compression they’ll face by the time the business achieves an exit. Today’s nosebleed entry valuations for most companies make this an unattractive trade. Investors who instead offer an ARR financing product can generate attractive returns simply betting on stability – rather than hypergrowth – and avoid competing to win allocations at stupid prices.

Key to success will be understanding how sticky ARR is in the era of LLMs, which create uncertainty around the durability and pricing power of certain software companies, and pricing risk accordingly.

CAC financing

A company’s GTM machine isn’t a tangible asset legible to most investors, but it’s a very valuable one. GC was the first firm to recognize this with its CVF strategy, providing capital to companies to invest in growth in exchange for a pre-determined IRR paid back only by revenue directly applicable to the S&M spend it finances. This is obviously attractive to companies with an efficient GTM motion and sticky customers: rather than sell a permanent stake in their business to finance growth, they can essentially borrow against the GTM asset they’ve created and maintain 100% of the upside once they’ve paid back investors. And it’s attractive to investors too: earn high-teens rates of return with relatively low duration and downside protection.

Investors financing CAC spend should be careful to work only with companies that can point to a well-defined, healthy relationship between S&M spend and growth. There’s a whole host of companies with undifferentiated products and upside-down GTM motions; even as company-building theoretically got cheaper, their burn rates exploded as they flooded the market with S&M spend to stay afloat. For companies like these, GTM execution is high and ought to be financed with equity – or, in a healthy ecosystem, not financed at all.

Data asset financing

Many software companies are really data businesses that aggregate, clean, enrich, and repackage proprietary data assets for their customers.

Companies like this almost always raise equity to create the data asset and build workflow tools on top of it. This is needlessly expensive. Instead, they should function more like specialty finance businesses: originate the data asset, securitize the licensing contracts, and access low-cost capital by selling them to investors who want exposure.

Over the next decade, many of these companies will realize they are steady but unremarkable businesses – instead of hyper-growth, venture-scale companies – that shouldn’t or can’t raise traditional venture capital. I expect we’ll see them engage the multi-strategy firms for novel database securitization transactions.

Other strategies

These firms will offer traditional preferred equity, ARR financing, CAC financing, database securitization, and a whole host of other solutions:

• Asset-backed lending: a more attractive cousin to venture debt, this will be especially important for AI companies hoovering up GPUs and hard-tech companies with significant land and equipment needs.

• New business models: venture buyouts (a terrible fit for traditional VCs but an exciting opportunity for investors who get creative around structure), “distressed” startup recaps, etc.

• Multi-billion dollar secondaries, mortgages for founders, majority stakes, fund-of-funds, etc.

• Creator financing: independent content creators are underbanked but have extremely valuable assets, all of which can be creatively financed.

Thank you to Neelay Trivedi, Abhi Desai, Aashay Sanghvi, Bala Chandrasekaran, Mohit Agarwal, and everyone else who weighed in on this piece. If you have questions, comments, or feedback, please reach out: andrewziperski [at] gmail [dot] com.

The views expressed herein are the author’s own and are not the views of Craft Ventures Management, LP or its affiliates.

1. Investors technically “buy” securities issued by their portfolio companies, but for the sake of this discussion, consider the products that investors “sell” their portfolio company customers

2. In practice, it doesn’t always work this way – earn-outs, management incentive plans, pay-to-play financings, and pre-exit cap table negotiations often mean investors (in practice) forfeit some of their liquidation preference