May 21, 2021Blog

Venture Investing in Flyover Country: Playing Small Ball in the Age of the Unicorn

It’s no secret that Silicon Valley and a handful of other venture centers absorb a healthy majority of all U.S. venture capital investment. Single venture rounds in the venture centers regularly exceed aggregate annual venture dollars invested in many States. For those of us out here in flyover country, while the occasional grand-slam is welcome, as a rule we play the venture capital version of small ball.

Fortunately, while VC small ball may not grab a lot of national headlines, it can be just as profitable, on a cash-on-cash return multiple basis (and IRR, if that’s your preferred metric), as the big ball game Unicorn investors play in Silicon Valley. The key is understanding how small ball venture capital investing is best played.

To understand small ball VC, a good place to start is Silicon Valley circa the 1960s to the 1980s. It was a time when the nurture venture capital model – a version of small ball – ruled the venture capital universe. It was a time when a $50 million venture fund leading a $5 million B round was big news.

The small ball VC model, then and now, is characterized by two critical elements. First, hands-on investing by venture investors with the personal experience, networks, and commitment to get down and dirty with entrepreneurs, often even before any financial investment. These folks see themselves more as company builders than investors. Second, an emphasis on weaning portfolio companies off of risk capital sooner rather than later - even if that means leaving some growth upside on the table. When you put these two elements of small ball risk capital together, you get the nurture venture investing model; the model that built the Silicon Valley juggernaut.

Today’s flyover country venture investors, or at least the large majority of the same with sub-$200 million pools of capital, should be playing the nurture/small ball venture game that was played so well by their Silicon Valley forbearers. They should look for deals that are capital efficient; where they are willing – and able – to get down and dirty with their portfolio entrepreneurs and add real value beyond capital before and after investing; and, where the initial goal as of the date of the investment is a company that can be profitable, or at least cash-flow neutral, within three rounds of venture capital representing an aggregate investment of something less than $10 million.

The nurture/small ball venture model reflects two key realities of venture investing outside the major venture capital hubs: limited numbers of smaller venture investors; and generally, less experienced entrepreneurs. The first reality demands capital efficiency – defined here as building a company that can (even if it chooses not to) sustain itself from operations with limited capital investment. The second rewards value added investors that can be effective mentors to their portfolio entrepreneurs, so that they can, in effect, punch above their weight.

An important reminder. The small ball venture game is not about smaller returns, just smaller deals. Whether looking at cash-on-cash or IRR, small ball venture investors are looking for the same returns – on smaller investments – as their big ball peers. (Shorter exit horizons might even give small ball players an advantage on IRR returns – though that, in my view, reflects a weakness of IRR as a return measure more than an advantage of the small ball model.) 

The small ball venture model comes with a variety of caveats and footnotes. Herewith a few of the more important ones.

  1. The precision of the model offered above – sub-$200 million funds; three rounds totaling $10 million to self-sustaining operations – should not be interpreted as hard and fast rules of the road for every corner of flyover country. The key variables (fund size; aggregate risk capital budget per portfolio company; number of rounds) will vary depending mostly on the breadth and depth of risk capital access and entrepreneurial talent of a particular region. The important point is that outside of major venture capital hubs, risk capital investors and entrepreneurs should calibrate their investment model to reflect the quantitative and qualitative risk capital and entrepreneurial deficits of their region relative to the major venture hubs.
  2. There are always exceptions – most of which prove the rule. It goes without saying that if Sequoia wants to start a company in Sticksville USA they won’t have any trouble (assuming the idea passes the blush test; probably even if it doesn’t) employing the Unicorn/Big ball venture model despite the location. Sticksville native Joe Sixpack, though, with same idea, almost certainly will.
  3. This model also suggests that businesses that are inherently not capital efficient, and cannot achieve self-sustaining operations without tens of millions of dollars or more of risk capital, should stay away from flyover country (again, allowing for the Sequoia exception). Biopharmaceutical startups, for example, should mostly locate in the larger venture capital hubs.
  4. Note that the early focus on attaining self-sustaining operations does not preclude a later, opportunistic shift to a big ball venture investment play. A small ball deal can evolve into a Unicorn opportunity, either before or after obtaining self-sustaining operations. The key is not counting on that when the initial investment is made.
  5. Small ball may not offer the glamour of Unicorn investing, but smaller, less established “off brand” investors often don’t have access to the big ball headliners in any event. For smaller and less proven flyover country venture funds, doing the best small ball deals is probably a better strategy than scrambling to get in what will likely be the dregs of the big ball deals. When life hands you a lemon ...

Small ball venture investing and entrepreneurship may not get many headlines, but it can be just as competitive, fun and profitable as big ball venture investing. If you are a smaller investor, looking to invest in areas with limited venture investing and high risk/reward resources and history, small ball is the game you should be playing.

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