Why Now Is (Counterintuitively) the Best Time to Launch A Venture Studio
Is this the end of venture capital as we know it? If you only read the news headlines, it may well seem like it. Startup valuations in freefall. Massive rise in startup layoffs. Venture funds pulling back on making new investments. Fundraising for new venture capital funds slowing. Yet these headlines do not tell the whole story. If you take a closer look at what’s happening in the venture capital ecosystem, the conditions are ripe for launching a new Venture Studio.
Venture Studios both build and invest in startups. They are also sometimes referred to as Company Creation Funds. The team over at the Vault Fund, a Venture Studio Fund of Funds, recently defined Company Creation Funds as entities that create their own portfolio of companies, with co-founder roles that garner founder ownership stakes at entry level valuations, backed by resources and processes to go-to-market at faster speeds.
We believe conditions are ripe for Venture Studios as the headwinds facing later stages of venture capital are turning into tailwinds at the earliest stages. This is strengthening the argument for Venture Studios as an emerging asset class. In this article, I’ll explain how new Venture Studios are benefiting from:
- Increased allocation of venture capital towards Seed and Series A as later stage venture remains frozen
- Institutional investors backing established Venture Studios and credentializing the asset class
- Corporations, universities, and government-related entities increasingly exploring new Venture Studios as a means for driving both strategic and economic returns
- Growing availability of and interest from high potential founders due to recent startup layoffs and shutdowns
Venture capital is flowing from later stage towards Seed and early stages, which has kept Seed valuations relatively steady.
Many later stage venture firms that were investing at Series B, C, or D are in a world of hurt right now. During the boom of the past few years, most invested in startups at historically high valuations and are now finding their portfolio companies facing down rounds at lower valuations or shutting down altogether. Later stage VC investing has essentially come to a grinding halt as the IPO window shut, M&A activity slowed down significantly, and founder and investor valuation expectations have yet to fully reset.
In response to the freeze in later stage investing, many LPs and VCs are moving quickly to reallocate capital towards Seed and Series A deals where valuations have been less impacted, even increasing slightly from Q1 to Q2 2023, and there are longer holding periods (typically 5-10 years to exit). Longer holding periods are attractive today as the assumption is that there is a higher probability of a frothy IPO/M&A market, with stronger exit multiples, in five to ten years as the macroeconomic cycle plays out and the economy bounces back. You can see this reallocation in the most recent data. According to Carta Insights, Seed as a percent of total invested capital has grown from just 4% to 14% over the past two years.
As a result, new Venture Studios, which create companies from scratch at the formation or pre-seed stage, stand to benefit from greater investor demand and relatively steadier valuations at Seed and A over the next few years.
Institutional investors are validating the Venture Studio model as an attractive asset class
Most institutional investors, such as pension funds, fund of funds, corporations, or sovereign wealth funds, typically take a "wait-and-see" approach when investing in new funds unless they have a long-standing, pre-existing relationship with the fund managers. Without pre-existing relationships, institutional investors require a long history of strong fund performance (e.g. 3x net MOIC or higher). These LPs typically do not commit until Fund III, when the projected returns from Fund I are becoming more clear and Fund II has begun to show early signs of success, such as multiple portfolio company markups.
While it's true that venture fund fundraising has dramatically slowed through the first quarter of 2023, many sophisticated institutional investors are still deploying capital into funds with truly differentiated strategies. Nothing is more differentiated than a Venture Studio in our opinion. While many venture fund managers claim “proprietary deal flow,” there is nothing more "proprietary" in VC than a Venture Studio that creates companies from scratch and sets the initial investment terms. Higher initial ownership levels combined with meaningfully higher probabilities of raising a Seed round is a powerful formula for delivering attractive returns to investors. Venture Studios can still deliver top quartile performance with a portfolio of "singles," "doubles," and "triples," and top decile performance if it hits "home runs" or "grand slams."
Notable institutional investors are deploying capital into the emerging Venture Studio asset class. For example, High Alpha Studio raised $18M for its third studio in 2021 from renowned venture capital firms Emergence Capital and Foundry Group. Atomic announced a $320M fourth fund with mostly institutional backers. Pioneer Square Labs recently announced it raised $20M for its third studio fund, again, primarily from institutional investors. This list goes on. For those fundraising for a new Venture Studio, these announcements can prove helpful in credentializing the model in the eyes of prospective investors. And as more institutional capital shifts into the Venture Studio Asset class, the more likely family offices, high net worth individuals, and other types of investors are to be willing to take a chance on a first-time Venture Studio.
Corporations, universities, and government-related entities are more likely to invest in first time Venture Studios as they can provide strategic benefits above and beyond economic returns
At High Alpha Innovation, we are in the process of raising several new Venture Studios with corporate, university, and government-related partners and are faring well in a very difficult fundraising market. While all Venture Studios must ultimately deliver attractive economic returns to successfully raise the next fund, our partners are often making a bet on a new Venture Studio for more strategic reasons.
Leading universities like Notre Dame have partnered with High Alpha Innovation to apply the Venture Studio model to further support commercialization of new technologies from faculty and students and create new venture-backable software startups targeting societal and environmental issues tied to the mission of the university.
For corporations of all sizes, innovation budgets are now getting cut in this difficult macro climate. As a result, these corporations are turning to partners like High Alpha Innovation to “innovate from the balance sheet.” Why? Funding a Venture Studio through capital investment can allow corporations to avoid negatively affecting their share prices due to earnings drag caused by P&L-funded innovation efforts, to reduce the longer-term cost of building new ventures by funding growth through outside venture capital, and to develop novel solutions more rapidly with world-class talent that aim to address internal problems and growth opportunities deemed strategically important to the corporation.
Finally, governments and related entities focused on regional economic development are realizing that traditional venture funds don’t really address the underlying problem: you can’t drive economic development and local entrepreneurship if there are no or few high-quality VC-backable startups to invest in! Many of these types of Partners rightfully view Venture Studios as an effective tool in addressing the supply-side problem of new startup creation in their regions. Similar to the jobs a new manufacturing plant might create, Venture Studios can be efficient in creating high-paying jobs when executed well. Federal, state, and local sources of funding that offset the operating costs of Studio teams are also making Venture Studios even more viable and attractive to investors. High Alpha Innovation and its partners are already leveraging great programs like SSBCI and SLRFR as sources of capital, for example.
We have seen success in combining the best of an established Venture Studio brand and playbook with the capital, network, credibility, and influence that these corporations, universities, and governments can bring to the table. Anchor investment alone goes a long way in establishing credibility with other prospective investors and jump-start the fundraising process.
The founder talent pool has grown exponentially and Venture Studios are an increasingly attractive option
In the boom times of 2020 to 2022, it was harder to attract and retain entrepreneurial talent as established companies like Microsoft and Google and venture capital-backed startups scaled their employee base rapidly. It was an all out war for the best talent. However, as the valuations of both large public companies as well as VC-backed startups have plummeted, these companies have been forced to lay off employees, flooding the market with capable founders looking for their next adventure. Anecdotally, our talent team at High Alpha Innovation has seen a notable increase in both the quantity and quality of our founder pipeline this year.
Founders, even repeat founders with multiple exits, are excited about the meaningful advantages that the best Venture Studios can provide. Put yourselves in the shoes of a founder interviewing for the CEO role at one of High Alpha Innovation’s new companies (or "NewCos"). Investment capital is already secured, typically $1M or more in initial funding that provides sufficient runway through a Seed round. There is a business concept that’s been meaningfully de-risked and validated with potential buyers and users. There is a brand identity for the company, a VC-ready pitch deck, high-fidelity interactive product mockups, and a thorough and objective investment memo. There are initial pilot customers and qualified design partners lined up. There is an entire team of HAI employees dedicated to setting up the NewCo and supporting founders on talent, network, and traction. And most importantly, founders still get a majority of the cap table in terms of equity ownership to ensure they have appropriate longer-term incentives, which is incredibly important to future investors. We often get asked by founder candidates: “Okay, what’s the catch?” We explain the “catch” is that they must dedicate their lives to building, scaling, and exiting the NewCo over the next 5-10 years.
Collaborating with established Venture Studios can increase the odds of launching a new Venture Studio
One aspect of my role at High Alpha Innovation is helping Partners explore the attractiveness and feasibility of launching a new Venture Studio. We work collaboratively with Partners to design the Venture Studio around their unique goals and constraints, to define the operating model and customize the startup creation process, to develop investor pitch materials and processes for raising capital, and to manage funds as General Partner or serve as Venture Studio operator. If you lead a corporation, university, government-related entity and are interested in exploring the idea of a new Venture Studio, we’d love to speak with you.
Now is (counterintuitively) a great time to launch a new Venture Studio.
High Alpha Innovation partners with the world’s leading organizations to drive innovation through startup creation, leveraging the Venture Studio model pioneered by High Alpha. As a Director, Mike Joslin partners with corporate, university, and government-related leaders to guide them through the Venture Studio formation and fundraising process.
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