Tag: venture capital

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.

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 inreased alpha via their more extreme divergence from benchmark returns.

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)

If the house always wins, build a casino

“Should we be concerned about a ‘Venture Deep State’? A ‘FOMO Industrial Complex’? Limbic Capitalism?”

Joe Milam, Founder of AngelSpan

A previous article discussed why venture capital has such a myopic focus on backward-looking metrics connected to ARR.

The summary is that people struggle with uncertainty, and there are two ways to cope: embrace it scientifically, or build a structure that lets people gamble on it.

Enter “casino culture”.

“Sports betting, shitcoins, meme stocks, vibe coding 100m in six hours, etc, are all expressions of the same deep cultural rot. If youth don’t believe there’s legitimate ways to get rich through work, all of culture will become a rotten sports book for the soul.”

Will Manidis

If you want to bet on startups, ARR provides a convenient metric to compress complexity and uncertainty into one dimension, reducing venture capital to a simple horse-race.

Investors make bets on momentum categories, riding the wave of revenue driven by large injections of capital, and hope they can raise another fund or exit before the music stops.

Combine that with the compounding influence of the “power law” meme, and the incentives to concentrate capital, you’ve got a real lottery on your hands.

Like an actual lottery, the net cash return is negative.

“It’s very difficult to invest money well, and I think it’s all but impossible to do time after time after time in venture capital. Some of the deals get so hot, and you have to decide so quickly, that you’re all just sort of gambling.”

Charlie Munger, Vice Chairman of Berkshire Hathaway

The beneficiaries of this limbic shift are the agglomerators, who play the role of “the house”; appearing to participate in the risk while harvesting beta from the associated activity.

For other investors, there are incentives to play:

Primarily, it gives GPs a simpler story to sell to LPs, inspiring greater confidence. They can enthusiastically shill consensus ideas and relationship-based access — which is exactly what many LPs want to hear, despite the poor returns.

Secondly, it diversifies away accountability. As more investors jump on-board the momentum train, individual career risk is exchanged for greater systematic fragility. When the market collapses, they can survive on relationships.

By turning venture capital into a game of chance, abusing the principal-agent problem, their job is greatly simplified: It’s the blue pill of steak dinners and congeniality, not the red pill of grinding hackathons and building portfolios.

Unfortunately, by abstracting the performance if investments from the underlying asset value with crude proxy metrics, the concept of “innovation” is mostly a mirage. It may be difficult to perceive at the time, when the traction feels real, but few truly important companies emerge from this environment.

“Consistently surprised by general lack of world changing ambition with seed stage cos and “early stage” VCs. Era of incrementalism still prevalent.”

Jimmy Yun, Investor at 8VC

Limbic capitalism produces what Byrne Hobart and Tobias Huber have described as “virtual innovation” in Boom: Bubbles and the End of Stagnation.

Essentially, a category emerges as the focal point for venture allocation, concentrating capital, and participants begin flipping coins under the long-standing premise that the upside of winners is always much greater than the downside of losses.

How could they possibly lose?

In the end, everyone eventually loses — except the house.

It turns out that the very behavior they engage in is destroying returns, and the only winner is the person collecting fees to manage the bank.

“Risk too much hunting jackpots and the volatility will turn positive expected value into a straight line to zero. In the world of compounded returns, the dose makes the poison.”

The Jackpot Paradox

(top image: “The Romans of Decadence , by Thomas Couture)