Report 1: Money Games - How Venture Capital is Changing

Claude Deep Research·

Money Games: How Venture Capital is Changing Wall Street Rules

The venture capital world is undergoing a dramatic transformation that most people outside the industry can't see. First Round Capital founder Josh Kopelman— [Apple Podcasts]one of the industry's most respected investors—recently outlined several key shifts that are reshaping how startup funding works and why these changes matter for entrepreneurs, investors, and the broader economy. [Apple Podcasts, Firstround, Mercury, NED Biosystems, Apple Podcasts, Spotify for Creators, Wikipedia, Phillymag, Spotify for Creators]

The big picture first

Venture capital has traditionally been a specialized, high-risk investment category where experienced partners bet relatively small funds on early-stage startups with huge potential. These investments typically involve long holding periods (7-10 years), hands-on investor involvement, and an acceptance that most individual investments will fail while a few massive winners deliver outsized returns. [Investopedia, Investopedia, Harvard Business Review, Visible, Angellist, Carta, AVC, Wikipedia, Hedge Fund Alpha]

But today, this model is being fundamentally transformed. Larger players are entering the space, fund sizes are ballooning, LP sources are shifting from university endowments to massive sovereign wealth funds, and technology companies are being valued (then devalued) in ways that create both opportunity and chaos. [Bain] Josh Kopelman has developed unique frameworks to understand these changes, which we'll break down in simple terms.

The "Blackstonification" of venture capital

Venture capital firms are increasingly resembling giant asset managers like Blackstone—a fundamental shift in how the industry operates.

What is Blackstone?

Blackstone is the world's largest alternative asset manager, with over $1 trillion under management. [Blackstone] Founded in 1985, it operates across multiple investment categories:

Unlike traditional VC firms, Blackstone:

How VC firms are becoming more Blackstone-like

Traditional venture capital operated very differently from Blackstone's model. VCs typically:

Now, prominent VC firms are adopting characteristics of large asset managers:

Sequoia Capital restructured completely in 2021, creating a single permanent investment vehicle called "The Sequoia Fund" that eliminates artificial timelines for returning capital and allows indefinite holding of public companies. [Sequoia Capital, Pro Buyer]

Andreessen Horowitz registered as a Registered Investment Adviser in 2019, expanded to manage $45B+ across specialized funds for crypto, bio, infrastructure, and more, and has attempted to raise a $20B fund specifically for AI investments. [Wikipedia, Andreessen Horowitz]

Tiger Global exemplifies this trend by investing across both public and private markets, [LinkedIn] deploying capital at unprecedented rates (335 investments in 2021), and managing over $95B across strategies. [Pitchbook, Crunchbase News, Tigerglobal]

What this means for you

For entrepreneurs, this shift creates opportunities to access larger pools of capital with potentially longer runways, but may come with increased pressure to scale quickly and pursue hypergrowth strategies that aren't right for every business.

For investors, these changes mean more options for liquidity but potentially decreased returns as strategies scale and competition increases. The personal attention founders once received from partners may diminish as firms grow larger and more institutionalized. [Substack]

Think of traditional VC as specialized boutiques run by former entrepreneurs who intimately understand startup building, while Blackstonified VC resembles financial conglomerates more focused on asset allocation and portfolio management than company building. [AVC]

The changing dynamics of Limited Partners (LPs)

The money fueling venture capital is coming from dramatically different sources than in the past, with major implications for how the industry operates.

Who are Limited Partners?

Limited Partners (LPs) are the investors who provide capital to venture capital funds. They're called "limited" partners because they have limited liability (only risking what they invest) and limited involvement (they don't make investment decisions). [Pitchbook, Everythingstartups, Seraf-investor, VC Lab 2.0, PrivateEquityList]

The relationship between LPs and General Partners (GPs) who run VC firms typically works like this:

The evolution of venture capital's money sources

Early days (1970s-1990s):

  • University endowments like Yale were pioneering investors [Wikipedia, Wikipedia]
  • Family offices of wealthy individuals backed early funds
  • Focus was on long-term returns with high risk tolerance [Goingvc, Wikipedia, Wikipedia]

Expansion period (1990s-2008):

  • Pension funds began allocating portions of their portfolios to venture
  • Insurance companies established alternative investment programs
  • International investors increased participation [VC Lab 2.0, Wikipedia, Wikipedia]

Today's LP landscape:

Why different money sources matter

This shift isn't just about where the money comes from—it fundamentally changes how venture capital operates:

Different time horizons: Sovereign wealth funds can think in decades rather than years, potentially allowing for longer company holding periods but also creating mismatched expectations with traditional VCs. [Nih, The FinReg Blog, Substack]

Risk appetite variations: Endowments traditionally have the highest risk tolerance, allocating 10-15% to venture capital, while pension funds maintain more conservative allocations of 5-10% to alternatives. [Inc42 Media, Substack]

Strategic vs. financial objectives: Corporate LPs often seek strategic insights alongside financial returns, [Angellist] while sovereign wealth funds may have implicit economic development goals beyond pure returns. [Everythingstartups, AVC, Goingvc]

Think of this like changing from small local investors who know you personally to massive international banks funding your business—the expectations, communication style, and ultimate goals shift dramatically.

The "Venture Arrogance Score"

Kopelman developed a concept called the "Venture Arrogance Score" [Apple Podcasts] to measure how unrealistic a fund's return expectations become as the fund grows larger. [Apple Podcasts, Deciphr, Substack]

The math problem of large funds

Venture capital funds operate under a clear imperative: they must deliver significantly higher returns than public markets to justify their risk, illiquidity, and fee structure. The industry standard target for venture capital funds is:

The problem? As funds grow larger, the mathematical challenge of delivering adequate returns becomes exponentially more difficult:

Small Fund ($50M) Example:

  • To return the fund 1x, a small fund making $2.5M investments needs just one company to exit at $50M (assuming 100% ownership)
  • More realistically with 5% ownership in each company, one portfolio company would need to exit at $1B
  • For a 3x fund return, you would need approximately three companies to achieve $1B+ exits, or one exceptional "outlier" exit [Chris Neumann, RBCx, Chronograph, Hackernoon]

Large Fund ($1B) Example:

  • With the same investment approach, a $1B fund would need 20 companies exiting at $1B each to return just 1x the fund
  • For a 3x return, the fund would need multiple multi-billion dollar exits
  • At 5% ownership, the fund would need several portfolio companies to reach $20B+ valuations [TechCrunch, Chronograph, Hackernoon]

The assumptions built into large funds

Large venture funds make several implicit assumptions that reveal their "arrogance":

Deal flow assumptions: That they can identify 10x more high-quality deals as they grow, and deploy capital efficiently without diminishing returns.

Investment opportunity assumptions: That enough billion-dollar opportunities exist and they can win access to the best deals despite increased competition.

Market capacity assumptions: That there are unlimited unicorns ($1B+ companies) available and exit paths (IPOs, acquisitions) can absorb more large private companies. [Investopedia]

The power law reality

Venture returns follow a power law distribution where a tiny percentage of investments generate the vast majority of returns. Often just 2-3 companies in a portfolio generate most or all of a fund's returns. [Toptal, NBER, iSelect Fund, TechCrunch, Hackernoon, Kruzeconsulting, Jack Altman, Phillymag, NFX, Andrewchen, Toptal]

As Kopelman explains, the "Venture Arrogance Score" increases when funds believe they can defy these mathematical realities. Larger funds need more outlier results to achieve their targets, yet the number of companies capable of delivering such returns remains stubbornly limited. [Kruzeconsulting]

Think of it like a fishing expedition: a small boat needs to catch just a few big fish to be successful, while a massive factory ship needs to haul in hundreds of times more fish—but there are only so many prize catches in the sea.

The historical uniqueness of venture capital

To understand these changes, it helps to recognize how venture capital traditionally differed from other investment types.

What makes venture capital special?

Venture capital has historically been defined by:

High risk, high return: Studies show that approximately 65% of venture deals return less than the capital invested, but the winners can deliver extraordinary returns. This is fundamentally different from most investment types. [Toptal, NBER, Institutionalinvestor, Hackernoon, VC Adventure, Toptal]

Long holding periods: The average time from investment to exit is 7-10 years, making venture capital extremely illiquid compared to stocks or bonds. [Pitchbook, Venturecapitalcareers, Wikipedia, Mergersandinquisitions, Peak]

Active investor involvement: Unlike most other asset classes where investors remain passive, VCs take board seats and actively guide companies through strategic decisions, talent acquisition, and future fundraising. [Angellist, AngelList, Goingvc, Sequoia Capital, Angellist, Azariangrowthagency, Montague Law]

Focus on innovation and growth: Traditional VC prioritizes investments in breakthrough technologies or disruptive business models with potential for exponential rather than linear growth. [Harvard Business Review, NBER, Wayra, Carta, Cbinsights, Wikipedia, Hedge Fund Alpha, Owlvc]

Venture capital vs. other investments

Venture capital differs dramatically from other investment categories across several dimensions:

Public stocks: Much higher risk than VC, with public stocks having volatility of approximately 15-20% annually while VC has 70%+ standard deviation. Public stocks have immediate liquidity while VC capital is locked up for 7-10 years. [NBER, BlackRock]

Bonds: Focus on capital preservation and income, representing the opposite end of the risk spectrum from VC with predictable, modest returns (historically 3-6% annually). [Pimco, Industry Ventures, Deutschewealth, BlackRock]

Real estate: More moderate risk with tangible assets providing downside protection that VC lacks. Average holding periods are shorter (5-7 years) with less dramatic return dispersion. [Angellist, Industry Ventures, Deutschewealth, BlackRock]

Private equity: While both are illiquid, PE typically invests in mature businesses with established cash flows, whereas VC backs pre-revenue or early-revenue companies with unproven models. [Angellist, AngelList, Investopedia, Investopedia, Wall Street Prep, Mergersandinquisitions]

Think of traditional venture capital as frontier exploration: high-risk expeditions into uncharted territory that occasionally discover new continents (like backing early Google or Facebook), while other investments are more like developing already-discovered land with known resources.

Tech companies vs. traditional businesses: The valuation disconnect

Kopelman described a fascinating phenomenon where companies are valued dramatically differently depending on whether they're classified as technology businesses or traditional businesses. [Phillymag]

The Allbirds example

Allbirds offers a striking example of this valuation disconnect:

This 98.7% decline happened largely because the market reclassified Allbirds from a tech-enabled disruptor to a conventional shoe company, completely changing its valuation metrics. [StockAnalysis, The Globe and Mail]

Other examples showing the same pattern

This dramatic reclassification has happened to numerous companies:

Blue Apron: Initially valued as a tech-enabled meal kit disruptor at $2.135 billion, later sold for just $100 million—a 95% decrease. [CB Insights Research, LinkedIn, Crunchbase News, Pitchbook]

WeWork: Positioned as a technology company at $47 billion valuation, later reclassified as a real estate company and valued at under $10 billion. [Cfainstitute, Insider, Nreionline, TechCrunch, Hedge Fund Alpha]

Rent the Runway: Valued as a fashion technology platform at over $1 billion, later viewed as a clothing rental business with high operational costs. [Yahoo Finance]

Why tech companies receive higher valuations

Several factors drive the valuation premium for technology businesses:

Growth rates: Tech companies often grow at 50-100%+ annually versus single-digit growth for traditional businesses. [Wall Street Prep]

Margins: Software companies achieve 70-85% gross margins while retailers typically have 30-50% gross margins. [Wikipedia]

Scalability: Tech companies can scale revenue without proportional cost increases, while traditional businesses typically require resource additions proportional to growth. [LinkedIn, Wall Street Prep]

Market potential: Tech often targets massive global markets or creates entirely new categories, while traditional businesses operate in more mature, defined markets. [Kruze Consulting, Etonvs, Full Scale, LinkedIn, Aventis, Finrofca, LinkedIn, Investopedia, Wall Street Prep]

This creates a situation where technology businesses might be valued at 10-20x revenue, while traditional retailers receive just 0.5-2x revenue or 5-10x EBITDA. When a company transitions from one category to the other, the valuation impact can be devastating. [LinkedIn, Etonvs, Nreionline, Kruze Consulting, Aventis, Finrofca]

Think of this like real estate: a building in Silicon Valley might sell for 10x the price of an identical building in a rural area—not because of the building itself, but because of what happens inside it and its perceived future potential.

Fund size and performance: Why smaller often wins

Despite the trend toward larger funds, historical data consistently shows smaller venture funds outperform larger ones. [Yahoo Finance, Institutionalinvestor, Axios, The Engineer VC, TechCrunch]

What the data shows

According to research analyzing over 1,300 venture funds:

This pattern has remained consistent across different market cycles and time periods. [Energytransitionventures, Institutionalinvestor]

Why smaller funds outperform

Several structural factors favor smaller funds:

The ownership math works better: A $50 million fund that invests $3 million for 15% ownership can return the entire fund with just one company exiting at $300 million. A $1 billion fund would need approximately twenty such exits or multiple multi-billion dollar outcomes. [LinkedIn, Chronograph, Toptal]

Better entry valuations: Smaller funds typically invest earlier when valuations are lower, enabling them to acquire larger ownership percentages for less capital. [Chronograph, Mergersandinquisitions]

Greater flexibility: Small funds can generate significant returns from exits in the $100-500 million range, which are much more common than billion-dollar exits. [RBCx, Chronograph, Fresco, Alphanome, The Engineer VC, McKinsey & Company]

The challenges of scale in venture

Large funds face fundamental constraints:

Limited deal access: The universe of startups that can meaningfully move the needle for a large fund is limited. [Chronograph, McKinsey & Company]

Ownership dilution: Large funds struggle to maintain significant ownership percentages without distorting company capitalization. [Chronograph, Founderequity, Toptal]

Partner bandwidth: Partners can effectively serve on a limited number of boards and provide hands-on support to only so many companies. [Chronograph, Sifted, Substack]

Exit requirement hurdles: A $1 billion fund targeting 3x returns needs to ultimately return $3 billion to investors—requiring multiple massive exits. [TechCrunch, Chronograph, Hackernoon, PitchBook, Toptal]

Think of fund size like boat size: smaller boats can navigate shallow waters and access hidden coves, while massive ships require deep harbors and can only visit major ports. Similarly, smaller funds can find success with modest exits that would be irrelevant to larger funds.

Conclusion: Why these concepts matter

Josh Kopelman's insights reveal an industry in transition, with significant implications for how innovation is funded and developed. [Apple Podcasts, Firstround, Apple Podcasts, Mercury, NED Biosystems, Phillymag] The "Blackstonification" of venture capital, changing LP dynamics, the mathematical challenges of fund sizes, and the valuation gap between tech and traditional businesses all interact to create both opportunities and challenges. [Spotify for Creators, Substack, Spotify for Creators, Apple Podcasts, Wikipedia, Phillymag, Firstround, Pro Buyer]

For entrepreneurs, understanding these concepts helps in selecting the right investors. A founder building a business with potential for a $200 million exit might be an exciting win for a $50 million fund but a disappointing outcome for a $1 billion fund. [Toptal]

For investors, these insights highlight the importance of fund size discipline and appropriate return expectations. The best venture investors understand these structural realities and design their strategies accordingly. [Substack]

And for everyone interested in how innovation is funded, these concepts explain why certain companies receive seemingly irrational valuations while others struggle to raise capital despite solid business fundamentals.

The venture capital industry will continue evolving, but Kopelman's frameworks provide valuable tools for understanding the economic realities that shape it. By recognizing these patterns, we can better navigate the complex intersection of capital, innovation, and value creation that defines modern entrepreneurship. [Apple Podcasts]