Are Venture Studios the next big advancement in VC?

Imagine a venture fund that has been around for 20 years and has launched over 70 companies. Of those 70 companies, 20 have had a successful IPO, 40 have been acquired and the 10 remaing companies are either earlier in their growth stage, or were shut down. In other words, the VC is getting 6 hits out of 7 at-bats - close to batting a 1000.  

Now compare that VC to their peers, who regularly average 1 hit out of 10 at-bats.  

Imagine further that the partners of this firm have a unique model in which they make their money not off of fees, but off of their returns. And it pays off – this VC has an average IRR of up to 50% (vs. 12-20% of peer VCs).

This imaginary firm actually exists in the form of two real-life funds: Sutter Hill and Flagship Pioneering. Their secret sauce? They describe themselves as operators, not investors.  As operators, they know what great product, great teams, and great go-to-market look like. They have a repeatable, systematic process for generating company ideas, filtering out the best, and scaling them.

They are very capital efficient as the portfolio companies are overseen and led by experienced teams. They play to win, being rewarded not by fees, but by larger carry in the form of their direct ownership in their portfolio companies.  

Not only does this new model of VC deliver superior returns to investors, they do it faster (more on that later).  

Is this approach the future of VC?  

Success in VC is all about what and how you build. Earlier this year, I wrote about my POV on the state of alignment in VC (between GPs and LPs) and laid out an approach that I like to call VC 2.0.

VC 2.0 is a sustainable way of investing that incentivizes value creation over managing fee income or placing fragile bets. It’s what we’re doing at the venture studio I co-founded, DVx. 

Since then, I’ve heard plenty of criticism of this model. Critics of this approach say that the studio model yields smaller returns compared to the traditional approach, that it’s slower to create value or can change the founder experience, and that good LPs don’t want to be part of a venture studio. 

But the data says otherwise.  As a result, I’m more bullish on this approach today than I was even just a few months ago when I wrote that first post. I’m convinced that the VC 2.0 approach doesn’t just work – it gives venture studios an advantage over the VC 1.0 approach.

Here’s why: 

Venture studios consistently deliver higher-than-average returns

As noted above, the average VC has an IRR between 12 to 20%. Venture studios have an average IRR of up to 50%.

This isn’t just a coincidence. This is the direct result of the care and precision with which venture studios build companies. The combination of an operator-first mentality and true product-market-fit yields fundamentally better businesses. 

Behind closed doors, most traditional VCs will admit that not all portfolio companies are created equal. They regard a select few of their portfolio companies as shining stars, then see the rest as either having a 50/50 shot at success or having little chance at making it. This means that somewhere along the way, they invested in an idea or an operator that they didn’t really believe in. Within the fund, it creates a tense environment where certain companies are under pressure to deliver big, while others get little support or resources from the VC. 

This doesn’t happen with venture studios. We give every idea an equal shot at success because we know that a good idea is just the beginning of building a good company. If we don’t believe in something, we stop investing in it. That means, we have to be very, very good at killing bad ideas early.

A startup’s idea only accounts for 28% of a startup’s success (Source: GSSN, Disrupting the Venture Studio Landscape). The rest of their success is derived from having strong, experienced operators at the helm and a proven product-market fit. The founders who lead these businesses are skilled and experienced operators who know how to build good companies by creating a perfect product, making strategic investments, and building a brand without an over-reliance on paid marketing. These founders are supported and rarely feel like they have to risk it all on a single decision or product or investment, just to make something of the company. 

And if an idea doesn’t work, we don’t force it. DVx’s ownership structure makes it easy to walk away from something that isn’t going to work - and we do so at the early stages.

We've vetted over 300 ideas prior to launching only 10 ventures across market opportunities worth over $1T. There have been times that we’ve walked away. Just this year we had two ideas that our team were really excited about, both of which had gone through our first vetting step, ensuring that these businesses were solving a real problem. But when we started meeting with potential customers to understand if we had product market fit, it became clear that we didn’t and that there wasn't a clear GTM avenue. We made the tough decision to stop working on, and investing in, those companies.  

Unlike a traditional VC, we stopped spending on these ideas the moment we knew they weren’t going to be winners. No capital needed to be returned or founders convinced. By focusing on the fundamentals of building strong businesses, you maximize the potential of every good idea. And it’s that maximized potential that showed up in returns for investors.  

Building smart doesn’t mean building slow 

The VC 2.0 model seeks to move away from some of the less effective aspects of the current VC model, which have rewarded a grow-AUM-at-all-costs mentality (to earn risk-free fee income). But growth can still be the number #1 priority of a venture studio, even if it isn’t growth at all costs.

Studios can only grow AUM so fast -- we are rate-limited by the number of companies our team can create each year.  And more doesn’t necessarily mean better.

VC 2.0 rewards smart, measured, and - most importantly - repeatable growth. This approach doesn’t just keep pace with the industry – it actually results in faster growth than the traditional model. 

A recent study shows that it takes 5 years for studio startups to be acquired - which is 33% faster than traditional VC-back startups. It takes about 7.5 years for studio startups to IPO, 31% less time than traditional startups.

We’re seeing the same thing at DVx, with our 10 portfolio companies demonstrating 50% faster growth compared to a traditional model.

We’re delivering big for our investors

DVx is on a path to return more than 6x to our investors in our first fund. Not only are our LPs unfazed by the fact that we are a venture studio, they invest with us because of it. When it comes time to fundraise, our VC 2.0 model is our not-so-secret weapon.

I know that many in the industry see this downturn as something we just have to survive. Weather the storm for a few years until headwinds change. But I truly believe there is more to this moment than too many VCs or too few quality new companies.

This is a time to change the model and how early stage investing is done.

There are so many incredible opportunities in front of us today. If anything, this environment has given us more clarity with which to spot the winners and has forced us to start creating value in a new way.  

It’s not only time to build -- it’s time to change how we build.