Checking in on the health of venture capital

Yesterday, a prominent former-VC posted a reponse to data from Beezer Clarkson, questioning how we understand the health of the venture capital industry.

His suggestion was that ‘number of active funds’ may not be the right lens, and that the fall may be a natural result of overfunding in 2021/22 and the “barbelling” of venture capital.¹

It’s a reasonable question. In reponse, I’d like to lay out three criteria by which we might be able to understand the actual health of venture capital.

1. Performance – how good VC is at returning capital
2. Progress – how good VC is at driving progress
3. Penetration – how good VC is at finding opportunity

From these three perspectives, we can triangulate the general health of the venture capital industry.

Performance

Broadly, performance appears to have slipped since the early years of the dotcom bubble.

This is nothing new, and no secret. Media coverage over the last 25 years has produced various iterations of “venture capital is broken”, followed by the industry assuring everyone that past performance is not indicative of future results.

“In the early sample (1981–2003), the levered-NDX replicator achieves an IRR of 23%, compared to 19% for the Cambridge Associates VC Index. In the later sample (2004–2024), the levered-NDX’s IRR of 19% exceeds the CA Index’s 12%, mirroring the vintage-level divergence.”

Venture Capital as Portfolios of Compound Options

While it’s difficult to get a good read on the performance of more recent vintages, it’s appears that something fundamental broke in 1997. The industry has yet to recover to the kind of benchmark-beating performance seen in years prior.

The most obvious suspect is the emergence of “scaled” venture capital funds, managing >$1B and firing it into every hot opportunity. On the surface, this behavior appeared to wash out of the market in the crash of 2000, however, there was a dramatic lack of consequences.

Indeed, the capital drought that followed was felt most keenly by peripheral hubs and managers. Those who had the least to do with the bubble ended up paying the steepest price.

Thus the “too big to fail” seed was planted in San Francisco venture capital, to emerge again a decade later.

A common rebuttal to this data is that venture capital is a power law industry, and so averages don’t matter. This is valid from the perspective of an individual firm, but clearly not in relation to the industry as a whole.

“From a public policy standpoint, however, market averages are more important than the individual returns of a few successful VCs, because most investors cannot reliably distinguish between high- and low-return funds.

After all, the notion that high risk requires higher returns is an old one, taught in every introductory finance course, yet the VC system, on average, is not providing this risk premium. Thus, the VC system bears a closer resemblance to another form of risk-taking: gambling.

Gambling also consistently offers low average returns but occasionally produces large payouts that are heavily skewed to a few big winners. And gamblers, like VC funds, tend to place their bets in the expectation that they will win one of these rare jackpots. But policymakers and the public should realize that average returns ought to be higher for risky investments than less risky ones.

If they are not, it is time to rethink the value of VC.”

The Crisis of Venture Capital: Fixing America’s Broken Start-Up System

The net cash flow data also illustrates the problem clearly; an investment strategy that extracts more capital than it creates is very hard to justify. And mirroring Jeffrey Funk’s statement above, continuing to invest in hope of the rare outsized fund return is gambling, not investing.

A major component of this weak performance is that inflated venture capital funds have compromised liquidity.

Previously, at a certain scale companies would have had to go public for further financing needs. Larger fund sizes delayed this, and IPO timelines have stretched from a historical norm of 8 years to the current average of 14.

And it’s not just a question of timelines. Long-term exposure to private market incentives distort businesses in a way that makes them less attractive to public markets (less profitable, higher failure rate, slower growth).

Essentially, venture capital wants to produce fragile ARR printers to harvest markups, and these businesses do not fare well in public markets which value financial health.

“Recent studies argue that the decline in IPO activity since the early 2000s is attributable to the rise of private capital markets. We add to this stream of literature by showing that the supply of venture capital also affects the type of firm going public. Specifically, we show that an increase in the flow of venture capital investment to a state leads to a decline in the average quality of IPOs from that state.”

The Rise of Venture Capital and IPO Quality

Thus, recent venture capital IPOs generally perform poorly and the liquidity endgame has been compromised.

Progress

“When I look back at the last decade, I think the following: There are some very wealthy people, but a lot of their incomes are from financial innovations that do not translate to gains for the average American citizen.”

The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better

Since the advent of the internet, it’s hard to pin down much tangible progress that is felt in our daily lives, beyond the cursed device — the mobile phone.

Indeed, while 2009 to 2022 was a period of historically low interest rates, driving down the cost of capital in private markets, the only real outcome was an inflation of fund size.

During this period, the venture capital industry funded the rollout of enterprise SaaS, and mobile apps, and then slowly ground to a halt on new ideas. By the latter half of the 2010s, capital was chasing electric scooter companies, rapid delivery, and questionable crypto applications.

In summary, in the period where capital was most abundant, it achieved the least. Technology was broadly stagnant.

This is largely down to the phenomenon which has been observed repeatedly throughout venture capital’s history: when capital inflows increase, they primary go to inflating “consensus” categories rather than broadening the scope of what gets funded.

“Increases in venture fund-raising which are driven by factors such as shifts in capital gains tax rates appear more likely to lead to more intense competition for transactions within an existing set of technologies than to greater diversity in the types of companies funded.”

Short-Term America Revisited? Boom and Bust in the Venture Capital Industry and the Impact on Innovation

The desire to raise funds more quickly, and deploy them at pace to raise again, means the most obvious ideas become the most appealing. This is another impact of the growth of fund size, which has produced a material drag on innovation.

It is fitting, and amusing, that the current shift (LLMs) is the invention of a non-profit initiated by an industrialist, hesitantly funded by VCs (Vinod Khosla famously apologised to his LPs for the OpenAI investment), based on research from a public company (Google).

Penetration

Great opportunities in venture capital are, intrinsically, outliers. They come from anywhere. Any industry, any location and any background. Thus, it is clearly in venture capital’s interest to have broad coverage.

Here we arrive at yet another problem with the large fund model; where the incentives align behind backing “obvious” founders (e.g. male Stanford grads building an AI startup in San Francisco) as a part of the internal promotion game.

Indeed, data shows that while the largest firms represent a growing percentage of early stage activity, they are also increasingly concentrating on “obvious” opportunities — despite evidence for outperformance of investments outside of the main hubs and outside of consensus categories. This is a reflection of choosing network effects and market capture over efficiency.

At the same time, investments in minority founders and female founders have been falling since 2021 — despite the case for outperformance in those groups. This is a simple reflection of venture capital’s reversion to crude archetypes of “fundability” that resrict access to a more concentrated set of opportunities.

This, plus large firms’ reliance on scout programs for deal flow, helps to explain why multiple studies have shown that VCs over index on founder attributes in the “fundable” Adam Neumann archetype. It leads directly to firms making predictably bad investments, and missing predictably good ones.

Even for the remaining small funds in the market, they aren’t necessarily independent. A surprising number have large firms (or large firm GPs) in their LP base, which distorts their priorities towards finding “obvious” ideas suitable for the large fund model. That’s in addition to the large firms role in anointing managers with capital and signal, influencing which strategies are funded.

Indeed, an increasing number of emerging managers appear to be spin-outs from large firms, where relationships are often maintained to trade deal flow for capital.

“Meanwhile, first-time managers continue to grapple with severe headwinds amid a prolonged fundraising slowdown. […] Of the 11 first-time funds that closed at or above $50 million, many had founding team members who were spinouts from a pedigreed firm.”

PitchBook NVCA Venture Monitor Q2 2025

While some of this may simply be the myopic fevor for AI in the current environment, driven by catering to LP interests, it is clear that the general direction is towards concentration and consolidation at a cost to well-distributed opportunity.

Conclusion

Revisiting the three measures listed above, we can summarise the status quo:

Performance is down.

Progress is down.

Penetration is down.

Venture capital is increasingly concentrated in the companies that most easily print markups, at a cost to founder opportunity, technological progress and exit opportunity.

The only group that appears to have benefitted from the last 25 years are the large fund partners, with their expanded fee income.

While there are other explanations that contribute to the trends here (e.g. the general stagnation of scientific innovation), the emergence of “scaled” venture capital during the period of low rates is an obvious unifying factor.

Finally, there is no barbell in venture capital.

There is no independent category of small, boutique firms, offering an alternative to large generalists for LPs. The whole ecosystem is enmeshed and hierarchical.

There are big firms who dominate the market via signal, follow-on capital and LP activity, and there’s a set of small firms who exist in service of the big firms, or in spite of them.

Framing this as a barbell distribution is a misrepresentation of VC that launders the maturity and stability of other asset classes.

(top image: “Untitled (Falling Buffalos)”, by David Wojnarowicz)

1. the death of the undifferentiated middle, as seen in other maturing asset classes that split into specialist boutiques and large generalists. [↩]

Innovation is chaos. Finance is order.

All attempts to finance innovation are torn between these two forces.

allocate, scale, concentrate / experiment, adapt, diversify

You can be a $15B venture bank, deploying across a set of branded thematic funds led by pod-shop style managers.

Or, you can be a $5M solo GP, investing in “weird stuff, early“.

The health of technology and venture capital depends on the balance between the two ends of this spectrum.

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Fragility

While many systems are entropic (tend towards chaos), financial systems are typically negentropic (tend towards order). There is increasing systematisation and regulation, aimed at developing reliability in the associated activity.

“Negentropy is reverse entropy. It means things becoming more in order. Here ‘order’ means organisation, structure and function: the opposite of randomness or chaos. One example of negentropy is a star system such as the Solar System. Another example is life.”

Wikipedia

In a venture capital context, this is reflected in the emergence of Tiger-style investement strategies, incumbent funds capturing a growing portion of LP capital, and the extreme attention on a few late-stage “hyperscalers”.

This often implies a loss of alpha, as fund strategies converge on consensus and returns converge on benchmarks. Not only do investors lose their edge, they also become fragile; susceptible to systemic shocks.

This direction favours larger firms that represent “institutional stewards” of capital, with more organisational structure and reputational capital to attract larger LPs.

Antifragility

In an entropic environment, resources aren’t allocated by design — they are spread broadly in a manner that increases the surface area of utilisation and opportunity. There is relatively little danger from overcapitalisation or overconcentration.

In a venture capital context, this is reflected in how fund of fund platforms, accelerators and emerging managers distribute capital across markets, industries and geographies.

“Entropic distribution of resources is critical for the health and resiliency of any ‘system’, including entrepreneurship and venture capital.”

Joe Milam, Founder of AngelSpan

Entropic distribution increases the likelihood that those who need capital will get it, at a cost to those who want a lot of capital — who may not. Capital flows out to a wider variety of people and ideas, without feeling the gravity of the “obvious”.

This direction favours smaller managers who represent greater risk, managed through greater diversification (smaller individual funds), and increased alpha via their more extreme divergence from benchmark returns.

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Walking the Line

There is a case for negentropy in helping to assemble large pools of risk capital to scale important projects in later stages. Whether that should be marketed as venture capital is another question.

It becomes problematic when the negentropic tendency of financial interests creates large pools of capital seeking excuses for deployment. This is a primary driver of unproductive bubbles.

Indeed, finding new opportunities to invest capital is the strength of entropic distribution, through managers that are less incumbered by structure and can more readily embrace the chaos of the unknown.

Today, it seems clear that the industry has heavily biased toward negentropy, first as a reaction to surging capital inflows, and latterly as a reaction to collapsing liquidity (created by that negentropy).

This must be corrected, not only because it’s an unjust outcome for small managers, but because their entropic distribution underpins the entire downstream capital environment.

(Credit to Jordan Nel’s fantastic article about antifragile venture capital, Joe Milam’s message about entropic distribution, and the excellent conversation between Peter Walker and Arian Ghashghai.)

(top image: Lena River Delta – NASA)

Venture capital is a pyramid, not a barbell

With the need to coordinate capital across successive rounds of funding, venture capital is functionally pyramid-shaped.

In theory, you start with small Seed funds, progressively larger funds through the Series rounds, and the largest pools of institutional capital for companies on the brink of exit.

This is mostly explained via crude “fund returner” math, where each investment is expected to be able to return at least 1x of the fund based on the round’s entry price.

This arrangement defies the pattern of most maturing asset classes, where there is an emergent “barbell distribution” of small specialists and large generalists, for three main reasons:

1. The (theoretical) need for a spectrum of different fund sizes to meet the range of capital requirements across the various stages of growth and funding.
2. The lack of independence, as boutique firms do not offer meaningfully different exposure, as they rely on follow-on capital from large firms for their portfolio companies.
3. The LP relationship, as boutique firms are often selected and capitalised by large firms for the purpose of generating market intelligence and deal flow.

In contrast, consider the division of PE:

Small and large are competing strategies. Boutique firms focus on small to mid-cap opportunities for growth potential while large firms focus on driving efficiency in large-caps. Boutiques may exit an investment to a large firm, but they do not share exposure.¹

So, what is referred to as the “barbelling” of venture capital is actually just an increasing top-heaviness, as repeated cycles of consolidation hit everyone except the whales and a handful of annointed/legacy boutique firms.

It’s not the shifting of the distribution outwards, towards each end of a spectrum. It’s the shift of capital upwards, moving it out of the “base” of boutique managers into the hands of large firms. Like a dangerous game of Jenga.

The resulting problem is that small firms are being consumed by the large fund strategy through their reliance on them as providers of both follow-on and LP capital.

Indeed, if you invest in a company today, who do you hope does the Series B? Increasingly, it’s a large firm.

A Seed firm must now prioritise companies with the potential to be fund returners for >$1B funds (especially when combined with LP enmeshment), which is a significant adjustment in strategy — and a major limitation.

This implies a smaller pool of relevant opportunities.

More capital being raised on shorter horizons.

More dilution.

More risk.

Stolen Growth

The growth in VC funds, chasing the incentives of larger LPs and the associated fee income, has necessitated larger exits.

How can an investment strategy manifest larger exits? Simple, hold them longer and feed them with more capital, which solves the allocation problem as well.

Effectively, this is growth transferred from public markets.

Most venture investors (particularly those without many exits to their name) would have you believe this is good; that public markets are burdensome and bad for innovation.

Not only are they wrong, they are obscuring the extreme cost of private capital, and the misaligned incentives in private markets (myopic focus on revenue growth).

In the past, venture-backed companies could exit at a range of sizes and still yield excellent, profitable outcomes. Today, the dumb assumption is that exits need to be huge, which conveniently fits the interest of large firms.

For everyone else, going public is beneficial. It’s good for unprofitable companies, and it’s good for innovative companies. It’s just not good for venture capital, because the large firms need somewhere to put their money.

“We find that less profitable companies with higher investment needs are more likely to IPO. After going public, these firms increase their investments in both tangible and intangible assets relative to comparable firms that remain private. Importantly, they finance this increased investment not just through equity but also by raising more debt capital and expanding the number of banks they borrow from, suggesting the IPO facilitates their overall ability to raise funds.”

Access to Capital and the IPO Decision: An Analysis of US Private Firms

To be clear about the consequences of this:

There are companies that could have achieved modest exits (great for small firms), which would have then compounded in public markets for decades. Many have been denied that opportunity because they seemed unsuitable for the large firm model of venture capital.

The implicit justification is that private markets are a better environment for growth, and so if a company isn’t suitable for private market investors it couldn’t become a good public markets opportunity either. This is incorrect on all counts.

Many companies will be able to hit IPO-ready metrics with less private capital than is force-fed to them today, and will fare better in public markets.

Indeed, there’s a point at which extended time in private markets will erode the appeal of a company for public market investors.

Thus, the increasingly top-heaviness of venture capital is:

• Limiting the range of companies that might be offered venture capital to begin with.
• Holding them private for longer, to absorb more capital and generate markups.
• Producing worse quality exit outcomes for everyone on the other end of the trade.

This is bad for founders, it’s bad for innovation, and it’s bad for the market. The only beneficiaries are those extracting fees..

Two years ago I suggested that venture capital needed to embrace divergence; to split cleanly into small and large funds that are in competition for LP dollars rather than enmeshed with each other.

This change would allow venture capital to grow towards the “barbel” distribution of mature asset classes, and would allow for targeted regulation that eased the burden on small firms while increasing scrutiny on the problematic large firms.

The case for this grows clearer every day.

(top image: “The Sea of Ice”, by Caspar David Friedrich)

(title inspired by a conversation between Bryce Roberts of Indie and Michael Dempsey of Compound)

1. A relationship I’ve argued that VC should emulate. [↩]

Many years ago, I was listening to a VC speak on a panel about how they made investment decisions.

At some point in this talk, he made a point that seemed to contradict many of my assumptions about the industry:

“An important consideration is how fundable an idea is; whether other firms also agree it’s a good prospect.”

The other figures on stage nodded sagely. Yes, an important consideration. 

Poor naive me. I had assumed that VCs were daring contrarians, and it turns out they’re riddled with the need for peer-validation?

Certainly, this wasn’t the attitude of venture capital’s forefathers. When did that change? 

No Consequences

This shift toward structural consensus-seeking is a natural consequence of unabated scaling in a fundamentally unscalable strategy. Cycles of boom and bust have failed to correct this ambition, as they’ve never really reached the core.

Indeed, as the industry has evolved (and the goalposts have moved) the incumbents of venture capital have become free to fail without having to face the cost of failure.

After the dotcom bubble burst, capital pulled back to the “safe haven” of San Francisco and consolidated in the incumbents that inflated it to begin with. The same has happened in every cycle since, most recently in 2022.

These cycles have decimated peripheral regional hubs that were home to vital industrial tech, like Austin’s “Silicon Hills”. They have also been particularly hard on smaller venture capital firms that lack track record and entrenched LP relationships.

So, while the giants of San Francisco’s venture capital scene may briefly decline in an absolute sense, they have continued to accelerate growth on a relative basis.  

There can be no switch it off and on again to restore the health of venture capital, in this context. Instead, there is the cyclical culling of insurgent firms and new ideas.  

“Venture capital firms, old and new, will continue to play a critical role in the innovation ecosystem by funding promising business ideas. These early signs of disruptions suggest challenger VCs will be formidable competitors in the future.¹

The Future of Venture Capital (2021)

If you remove the consequences for failure, and reward raw accumulation with stability, you invite the formation of hierarchies and rent-seeking behavior. The potential for performance slowly falls in line with whatever best serves incumbent interests.  

Venture capital’s bifurcation has been portrayed as “the inevitable death of the center” seen in other maturing asset classes as they diverge into ‘boutique specialists’ and ‘large generalists’.

However, this is not an accurate description of what has happened in venture capital or how the market is structured.

“Venture capital as currently constituted does not follow ‘venture logic’ in any real sense, and comparing it to other asset classes without explaining the particular points of similarity between them is laundering the reputations and structural stability of those other assets.”

Del Johnson

In no other strategy are the “boutique” firms so hopelessly dependent on the activity of “large” firms.

• Large firms may “anoint” a company with capital and signal, herding-in other investors, or they might be vocal about passing. Either may make-or-break a small firm.
• Even if they do choose to invest in a company, they retain the ability to crush earlier “boutique” investors with dilution or reward them with continued syndication.  

Large firms also have a wildly underestimated role in the capitalisation of new entrants.

• Through their LP activity, they influence which managers are able to raise funds, and therefore which strategies and theses may be tested in the market.
• From the firms they invest in, they’re able to collect data on the underlying portfolio companies which may have strategic value for their own investments.

Indeed, I recently conducted a survey of smaller venture capital firms on the makeup of their LP base. For funds raised prior to the crash in 2022, a staggering 93% had a large firm as an LP. This fell to (a still surprisingly high) 68% for funds raised since.

These stats raise a number of questions. To a cynic, it might appear as though large firms enabled the dependence of new entrants and then rug-pulled them when the market collapsed.

Certainly, this relationship doesn’t reflect the nature of the “barbell distribution” in mature asset classes — and is perhaps more “pyramid” in shape.

Hyper-fragility

The concept of “fundability” arose in response to the inflation of funding rounds with software’s appetite for growth capital (particularly in periods with low interest-rates). Thus, the ability to build large, well capitalised syndicates around a company became a core part of the venture capital playbook. 

Thanks to venture capital’s inclination toward “concentration without consequences”, the firms who were most influential in the coordination of these syndicates have been the most likely to survive across cycles.

Their ability to manifest a “synthetic consensus” (creating a localised area of low-cost capital) is now responsible for the majority of allocation into and out of venture capital — despite all of the obvious wisdom that contradicts signal-based investing.

This leaves the rest of the venture capital market with an unpleasant choice:

1. Go with the flow of this commensal relationship for the sake of survival. Deliver for incumbents by executing their thesis, surfing in the wake of their momentum, even if it means weaker ultimate performance for your fund. 

2. Operate as an independent, knowing that raising funds will be harder, securing follow-on capital for portfolio companies will be a battle, the paper growth of your investments will be slower, and if the market tightens up you’re highly likely to be put out of business. 

Increasingly, and unsurprisingly after three brutal years for fundraising, more are picking the former. They’ll “play the game on the field”, serving incumbents by herding into consensus like lemmings to support the anointed winners.

Thus, smaller managers are abandoning the hunt for Alpha, and instead pursue this mediocre strategy of “Beta to the Center”.²

The outcome is growing concentration and the continued erosion of returns across the whole venture capital strategy, particularly for small managers.

The one edge that small managers once offered over larger incumbents, the promise of outperformance, is also slowly being chipped away. 

(top image: “Gargantua”, by Honoré Daumier)

1. Narrator: They were mostly wiped out. [↩]
2. An obvious reference to There Is No Economy but Only the Debt to the Center [↩]

As described in a previous article, risk is the product of venture capital. If you do not understand risk, you do not understand venture capital.

In theory, the greater the risk an investment is seen to have, the greater the payoff if it works out. This is the skill of the venture capitalist; recognising asymmetry of risk and payoff.

In this calculation, there are essentially three categories of risk:

1. Idiosyncratic Risk
   The core of what is traditionally seen as venture capital, associated with investing in unproven ideas.
   
2. Systematic Risk
   The market-related risk in venture capital. The influence of shifts in sentiment or cost of capital.
   
3. Execution Risk
   The risk associated with building and scaling a particular solution, and dealing with competitive forces.

Any startup may have minimal or maximal levels of all three, although there are some relationships to explore.

• As an example of idiosyncratic risk, consider SpaceX. There was no space industry. There was no market map, playbook, or competition. It was like nothing else.
  
• As an example of systematic risk, consider OpenAI. The company’s success is heavily reliant on excitement about AI keeping the cost of capital low for large model providers.
  
• As an example of execution risk, consider Uber. The business clearly worked at scale, but reaching scale (dealing with regulators, unions, etc) was the central challenge.

Each risk category is a spectrum and all startups will have some degree of each. You’d have to go to extremes (e.g. a laundromat) to find a business close to zero risk.

e.g. for all that SpaceX is a champion for idiosyncratic risk, clearly there was also execution pressure. Similarly, OpenAI was highly idiosyncratic at inception, although that has changed over time as the AI market expanded.

Risk Relationships

While each risk exists on a separate axis, there are some risk relationships worth understanding:

Idiosyncratic risk is generally opposed to systematic risk

If a company is doing something truly original, it is unlikely to be relying on category hype to fund their development. Thus, a highly idiosyncratic company usually has low systematic risk.

That said, painfully novel ideas with an unclear path to profitability are less likely to be funded in cold markets. Investors will retreat to the safety of more knowable investments.

To understand this, we have to separate hype (AI, dotcom) from hot markets (early 80s, ZIRP), although often the two overlap. Each introduces a different flavour of systematic risk, one related to technology and the other to market conditions.

Idiosyncratic risk is generally opposed to execution risk

Execution risk is typically a product of highly competitive environments. If building a great company wasn’t hard enough, there is now a clock ticking on market saturation.

Implicitly, this is less of an issue for highly idiosyncratic startups who may be pioneering a whole new category with much more limited competition.

That said, some companies are so painfully idiosyncratic that there is also significant execution pressure. To court investors, they must keep smashing through development milestones.

In summary, there is a U-shaped relationship between idiosyncratic risk, and the two other risks. As covered above, the highest theoretical payoff comes when all three are maxed out.

Scaling Risk

Time and time again, in hot markets, incumbent firms have attempted to “scale” venture capital. That is, to find elasticity in the relationship between fund-sizes and risk, allowing individual firms to dominate large chunks of the market.

Each time, they have failed, because the risks outlined above do not scale linearly with fund size.

• Idiosyncratic risk is inelastic. It is the art of making good judgements about the future, and you cannot improve outcomes by throwing more people at the problem.
  
• Systematic risk is exponential. As you inflate a category or market, you herd-in capital which accelerates growth and raises the stakes dramatically.
  
• Execution risk is an unknown. There is a belief that patterns might reveal founders who excel at execution, but research largely indicates these are misleading.

If risk cannot be made elastic, then neither can fund sizes.

The largest firms cannot bear this reality, because a world where venture capital doesn’t scale eliminates any incumbent advantage; all firms must continually prove their right to exist.

Instead, they throw their resources at financialising the industry, creating a hyperreality where these risks are treated differently:

• “Consensus is good, actually“
  You don’t need to worry about scaling idiosyncracy if it’s not highly valued. In a world where consensus rules, the largest allocators will naturally rise to the top.
  
• “Escaping the cycle“
  Systemic risk already scales well, and a large firm is in the perfect position to amplify that inflation and ride-out the consequences of the subsequent crash.
  
• “The fundable founder“
  If a founder can keep raising money and generating signal, there’s a chance they’ll persist even with subpar execution. Especially with support from a large platform team.

Ultimately, this produces a “smart beta” strategy, reliant on market momentum and performance that isn’t directly connected to the quality of outcomes.

e.g. research finds that large, well-networked firms are more likely to inflate valuations and pump capital into consensus opportunities.

This drags venture capital away from its core purpose: the entropic distribution of capital to opportunity. Instead, it rewards concentration and accumulation, in firms and companies.

As a consequence, innovation suffers and returns slip. As hot markets have driven fund sizes and management fees up, with fewer firms in more dominant positions, technological progress has increasingly stagnated.

A less competitive environment is fundamentally less meritocratic, and the focus on consensus themes and pattern-matched founders excludes swathes of opportunity and potential outliers.

The future of venture capital, and whether financialisation deepens, depends on narrative dominance. If the market continues to reward consensus seeking, concentration and dogmatic belief, the trend will persist.

It’s the kind of existential question which would lead large firms to fund social media bot farms, groom tech influencers, and play a growing role in the media side of venture.

(top image: “Untitled 2”, by Julie Mehretu)

Venture Capital’s Search for Scale

A recurring question in each techno-financial cycle: “Can venture capital scale?”

Each time the market is primed with enthusiasm, and the macro stars align, fund sizes swell and managers promise that this time it will make sense. Inevitably, returns fall and the market contracts, yet it’s the greatest accumulators that survive.

Thus, the goalposts have gradually shifted towards scale, and the market has nudged its way towards “hyperreality” — celebrating the signals of success.

The Liquidation of Referentials

French philosopher, Jean Baudrillard, argued that society has moved from a “real” economy (based on production and utility) to a “hyperreal” economy (based on simulation and sign value), when signals offer disproportionate reward.

For example, a wealthy individual may buy a Ferrari as a reward for their hard work. Another person might buy a Ferrari on credit to access the status of perceived wealth.

Alternatively, a successful VC will end up accumulating “unicorns” in their portfolio. Alternatively, a VC that wishes to appear successful might offer “unicorn” terms to their portfolio companies.¹

This behaviour reflects the “liquidation of all referentials”, where the signal itself becomes desirable, rather than the underlying reality.

Thus, as explored below, venture capitalists (particularly in hot markets) less frequently fund “reality” (idiosyncratic, novel innovation based on practical demand), and more frequently fund “simulacra” (scalable software models that simulate value through rapid growth detached from physical constraints).

A History of Hyperreality

It’s in our nature to want to leave a legacy, and typically that’s either through quality or scale. Which of these is easier, and more appealing, is a reflection of where we’re at in the grand boom-and-bust cycle of financialisation.

“Financialisation” itself essentially refers to something like hyperreality in the narrow context of financial markets.

In recent years, it appears that scale and accumulation have become the primary objective. While it has become more obvious (and more widely discussed) in the last five years, the origin goes back a decade further. Indeed, much credit goes to Seth Levine for calling “bifurcation” as far back as 2010.

Implicitly, we have then moved in the direction of hyperreality and the pursuit of signals — but can it be demonstrated empirically rather than just theoretically and philosophically?

To assemble a more complete picture, we can compare studies on various periods of venture capital activity and the “revealed preference” in the data:

• Boom and Bust in the Venture Capital Industry and the Impact on Innovation (2002), by Josh Lerner of Harvard Business School
• Investment Cycles and Startup Innovation (2011), by Ramana Nanda of Imperial College Business School and Matthew Rhodes-Kropf of Harvard Business School
• Venture Capital’s Role in Financing Innovation: What We Know and How Much We Still Need to Learn (2020), by Josh Lerner of Harvard Business School and Ramana Nanda of Imperial College Business School
• Scalability, Venture Capital Availability, and Unicorns: Evidence from the Valuation and Timing of IPOs (2023), by Deepak Somaya and Jingya You of the University of Illinois at Urbana-Champaign
• Unicorns, Media Fame, and Dumb Money: The Strategic Inflation of Unicorn Startups’ Valuations (2025), by S. Joseph Shin of University of Washington, Sunu Kim of Korea Advanced Institute of Science and Technology (KAIST), and Haemin Dennis Park of University of Texas at Dallas

From the 1960s up until 2020, there is a surprisingly clear shift of investor priorities which aligns with Baudrillard’s theory of “hyperreality”.

In the first paper, covering 1965–1992, the authors found that venture capital is broadly less efficient in hot markets. Capital overshoots the opportunity, duplicate companies are funded, and the per-dollar return of the strategy slides. This is essentially the origin of “venture capital doesn’t scale”, and a hypothetical ceiling on appropriate allocation.

In the second paper, covering 1985–2004, the authors found that venture capitalists tend to invest in companies with greater risk during hot markets. The distribution of outcomes widened, with a greater rate of failure but higher valuations for successful exits, alongside more patents and patent citations.

“The flood of capital in hot markets also plays a causal role in shifting investments to more novel startups – by lowering the cost of experimentation for early stage investors and allowing them to make riskier, more novel, investments.”

Investment Cycles and Startup Innovation

Here is where the divergence begins, with the Great Financial Crisis and an extended period of low interest-rates coinciding with the rise of scalable cloud-based software with subscription revenue. There is marked change in the risk appetite and preferences of venture capital, shifting towards the hyperreal.

In the third paper, covering 2010–2019, the authors found that venture capitalists had narrowed their focus on software companies in recent years, leaving other (more “real”) sectors bereft of funding. Particularly, that this did not appear to be connected with greater opportunity in increasingly crowded software markets.

“While venture funding is very efficacious in stimulating a certain kind of innovative business, the scope is increasingly limited. This concentration may indeed be privately optimal from the perspective of the venture funds and those who provide them with capital. It is natural to worry, however, about the social implications of these shifts.”

Venture Capital’s Role in Financing Innovation: What We Know and How Much We Still Need to Learn

In the fourth paper, covering 2010–2019, the authors found that venture capitalists have increasingly pursued scalability during hot markets — rather than greater novelty, as described in earlier research. Instead of a greater appetite for idiosyncratic risk (associated with innovation), it was execution risk which grew (associated with experimental scaling strategies).

Significantly, these investors choose to keep these companies private in order to absorb greater levels of private capital, rather than seeking an exit — and a reckoning with reality. As long as value appeared to grow at the desired rate, there were no unplesant questions about the reality of it.

In the fifth paper, covering 2005–2019, the authors found that “centrally located” (connected, influential) investors will syndicate to inflate a company to “unicorn” status for the purpose of grandstanding. The newly minted unicorn will then more easily attract subsequent investment from “lower quality” investors, like moths to a flame.

The tyre-marks of hyperreality are clear in the post-2009 data, where a period of capital abundance did not result in more ambitious companies being built, but rather a more ambitious approach to scale. Rather than bigger ideas, venture capitalists pursued ideas of bigness.

We have since seen that this behavior (predictably) left more than 600 “zombie unicorns” stranded when the market contracted. Companies that were only really “unicorns” in a hyperreal sense; frail simulcra of billion-dollar businesses.

Further research shows that such “well connected” investors tend to perform better in hot markets, and worse in cooler markets, which illustrates the damage done when a market correction shatters the illusion of performance.

The Hyperreal Market Mirage

Putting all of this together, we can establish the following:

Investors found that success does not scale in venture capital, as a greater volume of capital simply widens the distribution of outcomes and erodes the aggregate returns.

However, signals of success do scale. If you treat “unicorns” as a measure of success, where success brings you more capital, you can create as many unicorns as you wish.

Thus, after a period of immense accumulation during the post-GFC low-interest-rate period, venture capital embarked on a spree of unicorn creation with the goal of compounding success into durable competitive advantage.

During this time, influential investors led syndicates that anointed unicorns, encouraging founders to stay private in order to absorb more capital, print more growth, and post increasingly impressive virtual performance.

In Q2 2022, the market was forced to reckon with reality as inflation set in and prompted a serious escalation of interest rates. Suddenly, LPs were keen to know exactly how “real” the reported performance was.

Today, the market is not particularly conducive to “hyperreal” investing, as skepticism of venture capital behavior remains. However, the most influential firms aren’t going to let this go; scalable venture capital is the promised land of compounding advantage and ultimate oligopoly.

So, they manifest the hyperreal by wrapping certain parts of the industry in narrative. They invest heavily in both creating and manipulating media to influence the perception of opportunity and performance.

By bending their apparatus toward a particular narrow band of influence, they are able to continue achieving scaled “success” in the simulation.

Secondary transactions, and the “democratisation of private markets”, are your ticket to participate in hyperreality, and the opportunity to become deluded exit liquidity for these accumulators.

Or you could join the smaller (and less visibly successful) pool of investors who stubbornly grapple with reality.

(top image: “The Matrix”)

1. Or a group of VCs may organise around systematically assigning unicorn status to companies, rather than investing in companies that will earn it. [↩]

Early-stage VC can be one of two things:

• A complex, collaborative and positive-sum discipline
• A simple, adversarial and zero-sum competition

The difference between the two is whether or not you pretend there’s a legitimate consensus on “good deals”, and therefore whether competition and access are meaningful forces.

If you embrace this fantasy, a few convenient things happen:

1. You can win at VC by brand building
2. You can win at VC by exploiting relationships
3. Venture capital becomes “scalable”
4. Capital and influence concentrates

Thus, venture capital morphs from a loose collection of boutique investors into an oligopolistic mob.

The rent-seeking behavior this enables is so seductive that it has been able to resist all contrary evidence:

• Venture capital exhibits weak persistence of performance
• Relationships do not contribute to persistence
• Consensus investments underperform
• Scale erodes returns

What’s left is an industry with few leaders and many followers. For the weak-willed majority, conviction atrophies and cements their position as vulnerable minor parties in a commensal relationship.

While this is problematic in a few obvious ways (the failure of fiduciary duty to LPs, the failure to founders), there is one critical issue: it completely undermines the positive-sum attitude that has been central to venture capital’s success.

Finite Games and Infinite Games

You might hear investors saying that venture capital feels more competitive than ever. What they really mean is that venture capital is more adversarial than ever.

As power and capital concentrates, and the focus is increasingly on winning a finite number of the “best” deals in each vintage, venture capital is necessarily less competitive.

Truly competitive games are infinite games. You don’t just care about winning, you also care about the scale of that win.

To use basketball as an analogy:

A finite game player might simply care whether or not their team wins the next game, and the next championship. As long as they win, that’s all that matters.

An infinite game player cares about stats like the ~42,000 US city parks with basketball hoops. They care that ~40% of 13-17 year olds regularly play pick-up basketball, and the ~18,000 US high schools that sponsor basketball programs.

Many competitive pursuits die as a finite games because they are dominated by an early elite who are hostile to newcomers and casuals. They choose winning smaller victories over competing for a larger outcome.

Venture capital, the success of Silicon Valley, and much of today’s technological progress, was built on an infinite game: The pursuit of abundance through innovation, rather than simply dominating the status quo.

When an investor (either GP or LP) says indiscriminately that VC does not need more capital, they are implicitly using a finite game lens. They prefer that competition is restricted, and cannot see how that also limits the scale of opportunity for the category as a whole.

In the US, this attitude is becoming a problem as boutique firms are displaced by agglomerators. While the two aren’t in direct competition for LP dollars, the environment is increasingly defined by the participants with the most influence.

In Europe, this attitude is an entrenched problem. European venture capital did not emerge from an infinite game mindset as it did in the US. For all the anecdotes about Europe’s merchant banks, venture capital is an import that has quickly been seized by opportunists. This is why Europe’s venture capital scene has remained relatively small, at a cost to growth and prosperity. There has never been a vision for abundance.

City Parks for Entrepreneurship

If you want to take an infinite game approach to venture capital, you need to care that entrepreneurship is accessible, and that the interface between capital and talent is healthy.

To the agglomerators, this interface is addressed by scout programs where ambitious young adults seek startups that fit a pattern — as the incentives are to optimise for partner approval. So, more capital flows into SF/NY, Stanford and Harvard Grads, ex-Mag7 employees, AI tools, etc. The pool of opportunity narrows, but you aim to win more of it.

To the boutique investors, this interface is addressed by scouring college campuses and builder communities. They are looking for outliers; the people with ideas so outlandish that it may not have even occured to them to seek investment yet. The pool of opportunity grows, and you may win more of it.

The former is obviously a finite game. The latter is obviously an infinite game.

If the goal is (as commonly stated) the pursuit of abundance through progress, venture capital is implicitly an infinite game and we should care deeply about the entrepreneurial equivalent of city park basketball courts; distributing awareness, access and opportunity as widely as possible.

The fact that so much of the industry is focused on gatekeeping and exclusivity is an obvious signal of distress.

Rothenberg’s Paradox

A paradox in this story is that the scale of capital going to the finite game is much larger, and is growing more quickly.

How then is that the finite game?

This reflects what we might call Rothenberg’s Paradox: any successful infinite game creates opportunity for rent-seeking via finite game players. The scale of capital becomes the central opportunity, like a snake eating its own tail.

For now, venture capital maintains the illusion of a booming industry with growing opportunity — while it’s really just getting better at financial engineering and wealth extraction.

(top image: “Pollice Verso”, by Jean-Léon Gérôme)