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