“Smart idea, grounded on exhaustive research, followed by a big bet.” – Julian Robertson
There is no arguing Venture Capital is being transformed by a sweeping wave initiated by a handful of so-called cross-over funds, the most visible being Tiger Global—whose origins are tightly related to Julian Robertson. Rarely a week goes by without the announcement of a mega-deal led by Tiger, Coatue, and consorts. Traditional VC firms have so far behaved like the incumbents the startups they invest in disrupt. First, they dismissed Tiger’s strategy. Then, they condemned it. Now, they’re both afraid of it and wondering what to do to continue existing.
In this post, I go back to Julian Robertson to tell the origin story of Tiger Global’s strategy, and explain how the cross-over players apply the Disruption playbook to Venture Capital. I then wonder why Venture Capitalists took so long to react to this new wave, looking at how and why our beliefs resist change so much.
Note: you can watch the recording of a recent live webinar on this topic here. I demonstrate how Tiger and co. are disrupting the traditional late-stage VC model.
The Origin Story
Tiger Global’s story starts in March 2001, when a 26-year old Wall Street financier called Chase Coleman sets up shop with a $25 million mandate from his former boss, Julian Robertson.
Robertson was one of the most successful hedge fund managers of his generation. His firm, Tiger Management, went from $8 million in assets under management in 1980 to $20 billion at the end of the 1990s. BusinessWeek ranked it the second-largest fund in the world in 1997. He was called the Wizard of Wall Street. When he shut down his fund in 2000, Robertson spun off a number of “Tiger Cubs”, helping former employees launch their investment activities.
Chase Coleman initially named his firm Tiger Technology, then changed it to Tiger Global Management. The homage to his mentor extends beyond the fund’s name. Coleman implemented many of the lessons he learned from the Wizard, becoming one of the most astute investors of his generation. His personal wealth is estimated at $10 billion.
Tiger Global lost money only two years since 2007, beating the hedge fund industry by a wide margin almost every year.
16/ As of today, Tiger’s L/S fund has compounded at 21% net since its ’01 inception, with only two down years (’08 and ’16). pic.twitter.com/xQJmUEI0px
— Nihar Sheth (@nsheth12) June 29, 2021
Perhaps the most impacting of Robertson’s lessons to Coleman is this week’s quote: having a smart idea, corroborating it with thorough research, then taking a huge risk. Not unlike the VC approach—at least, the VCs of old.
The irony is that Coleman applied this methodology to disrupt the Venture Capital asset class.
Why Tiger Global’s Strategy Works So Well
From the outside, it seems that Tiger Global is winning by “shooting from the hip”, like Clint Eastwood in 1960s Western movies. Ultra-light due diligence, sky-high valuations, and break-neck speed in closing deals are the most frequent reproaches made by traditional VC firms about the cross-over fund.
Roberts said that he also heard of an instance when Tiger Global doubled the terms of what a growth-stage VC was offering for a company—from a $125 million round at a $1 billion valuation to $250 million at a valuation of $2 billion—after reviewing the company for a mere 48 hours.
Source: Pitchbook
In fact, Tiger found a promising segment in the VC market and started piling huge amounts of cheap capital into it.
There seems to be no shortage of Founders who raised Series A rounds, have a fairly good Board, a clear strategic plan, and just need money to execute it. They don’t want what traditional VC firms have to offer—or claim they do. These entrepreneurs just want cheap money and no strings attached.
It seems to work. According to Crunchbase, Tiger made 114 investments in Q4 2021, up from 32 in the same quarter a year earlier.
The complaints aired about Tiger are similar to those heard about the Softbank Vision Fund when it started deploying its $90+ billion mega-fund a few years ago. Tiger is accused of taking all the best opportunities at crazy prices, pushing market practices in the wrong direction. Founders awash with money, some say, are not building long-lasting companies but “flipping assets”.
Tiger is also frequently accused of shamelessly free-riding the top VC firms’ hard work. Once a startup receives a term sheet from an elite investment firm, thus validating the company’s quality, cross-over funds are said to swoop in and offer better terms to win the deal.
As Christensen brilliantly demonstrates in his book, The Innovator’s Dilemma, incumbents are displaced by new entrants who offer a product that is good enough, at a lower price. The market leader prefers flight to fight, becoming gradually less relevant for an increasing number of clients.
I followed a three-month course on disruption on the HarvardX platform a few years ago. There is no doubt in my mind that Tiger and consorts are following that strategy with the Venture Capital asset class. While also following Robertson’s rule: having identified a gap in the VC market, they are making a big bet by championing a new way of taking unicorn real estate.
Cross-over funds benefit from a key weapon in their arsenal. They seem to satisfy themselves—and their investors—with lower returns. In a market where 5x is becoming the new 3x, having access to cheaper capital, in the form of lower return expectations, is critical to winning.
Another feature of disruptors is that they possess a structure—in Christensen’s words, “resources, processes, and a profit formula”—allowing them to execute their low-end strategy. Everett Randle, a VC at Founders Fund, was one of the first to write an extensive analysis of the processes put in place by Tiger to deliver on their high-velocity capital deployment strategy. Randle correctly assessed that Tiger, Coatue, et al. “play a different game”.
In the past two years, Tiger has developed an entirely unique investment platform in venture/growth based on Maximum Deployment Velocity and Better/Faster/Cheaper Capital for Founders. These two pillars represent the most significant development in venture strategy since the advent of the growth fund.
Everett Randle (Founders fund)
Why Are Traditional VCs Resisting This Change?
What surprised me most when I started analyzing this new trend almost a year ago, is how Venture Capitalists reacted to it. Many were quick to make fun of the speed at which Tiger closed deals and the high valuations that went with them. Some Founders followed suit.
Others dismissed what they called a fad, blaming all the market’s woes on the “tourists”, new entrants who don’t know the rule of the game and will be washed away when the next market correction hits. There is a recurring pattern in Venture Capital—and most Private Equity sub-classes—on how bubbles grow and burst.
Contrary to what many observers believe, however, Tiger Global is not new to the VC game. It started investing in private markets since the launch of its first dedicated fund in 2003. Over the years, Tiger took both early primary and secondary positions in huge financial successes such as Zynga, LinkedIn, Flipkart, Facebook, JD.com, Xiaomi, and Coinbase, to name a few.
I believe it explains how Coleman identified the market opportunity: Founders who want money fast, with minimum meddling from their investors. Late-stage VC investing is a fertile ground for such a capital deployment strategy. By that time, startups have a Board filled with smart investors and a proven roll-out plan. All they feel they need to succeed is money.
If you read my blog posts and watch my live webinars regularly, you know I like to go beyond the cognitive domain to the neurological and psychological areas. I believe it’s where real truths lie.
In this case, Venture Capitalists have not been unable to recognize the tidal wave disrupting their turf due to a lack of understanding. Most of them are not only aware of disruption laws, but they have also helped create them. So, what else is at play here?
Illusory Truth
One stream of cognitive psychology that has gained momentum in recent years is beliefs change. The last U.S. election cycle and the controversies around scientific evidence about the Covid-19 pandemic have no doubt participated to this evolution.
A concept called the continued influence effect may help explain why VCs have been slow to recognize—and, in some cases, are still denying—the new disruptive trend in their asset class.
Psychological experiments conducted in the 1980s and 1990s showed that when we learn about a new fact discrediting former information we held as true, we have trouble adjusting to the new truth. The old fact, now proven wrong, has a continued influence.
Complex mental mechanisms seem to play a role here, such as wishful thinking and, more profoundly, the availability bias—championed by Nobel prize winner Daniel Kahneman. I wrote about Kahneman’s research in another post, showing how the representativeness bias can explain the lack of diversity in Venture Capital.
In this post, I resort to another type of bias, the availability one, to understand why VCs have been so slow to react to the Tiger threat. The availability heuristic is a common way humans use to make judgments of frequency and probabilities. Events that appear easily in our memory—they are available—are used to infer the outcome of a given situation.
Tversky and Kahneman (1973) take a simple example to illustrate this point. They take the imaginary case of a clinician trying to assess the likelihood that one of his patients, who recently complained of being tired of life, will commit suicide. The clinician will research his memory for past patients who committed suicide and try to evaluate the similarities between them and the one presently under care. He may, however, make at least two assumptions that are potentially tainted by the availability bias. Firstly, the clinician may omit all depressive patients who didn’t commit suicide. Secondly, he may not have encountered any patient like this one in the past. In both instances, the clinician is likely to make an incorrect prediction based on the availability bias.
A psychological analysis of the heuristics that a person uses in judging the probability of an event may tell us whether his judgment is likely to be too high or too low.
Tversky & Kahneman (1973)
Likewise, Venture Capitalists who have been through bubble and bust cycles before may recall all the “tourists” that tried new ways of doing the job and ended up ruined. The memory of these new entrants is quite available to them, as the Doug Leone interview suggests.
These VCs are subject to illusory correlations, which explains why they don’t draw correct predictions when analyzing a trend—an ironic situation given that a large portion of their job consists of making judgments on which products, services, and technologies will become prevalent in the future.
To be fair, some traditional Venture Capitalists called the Tiger trend early.
Have to respect the operational speed & investment conviction of leaders at Tiger Global, Addition, Coatue — making moves in venture, even at seed / Series A. “Tiger Cubs” on the loose.
— Semil (@semil) February 15, 2021
I would argue that Semil Shah is an atypical Investor, in that he operates a small and very active fund. He’s ideally placed to understand how difficult it is to build an infrastructure to deploy capital quickly. In other terms, he’s primed for the problem.
Motivations For VCs To Resist Change
There is another possible explanation for the resistance to change in Venture Capitalists regarding this disruptive wave. VCs have both external and internal incentives to refute the need for an altered way to not only look at the market but also modify their behavior.
The external motivation can be easily explained. VCs get paid to identify potential winners, negotiate balanced terms, add value to their growth trajectories, and sell their shares with a large capital gain.
They are well compensated if they do it consistently, in the form of a profit-sharing scheme (called carried interest) and a flat fee (called management fees). Watch my webinar How Much Do Venture Capitalists Make? if you want to dig deeper into VC compensation.
It stands to reason that going the Tiger Global route would make it harder for VCs to justify their compensation to their investors (called Limited Partners). Tiger and consorts essentially chip away at the core of the VC job in all steps of the Venture Capital cycle:
- Identify potential winners. cross-over funds mostly invest late-stage, which makes the analysis much easier as you have data to look at. Tiger participated in only 19 Series A rounds out of the last 100 announced deals on Crunchbase at the writing of this post. They seem to implement a mix of first-principle approach and free-riding, which explains how they can turn over term sheets in less than 48 hours.
- Negotiate balanced terms. See point above. Offering huge valuations and no asking for Board seats make this step a quick and painless one.
- Add Value. Ditto, no Board seats equals no Founders’ expectations in that respect. Tiger attracts companies that already have Boards and feel they only need the money, no strings attached. I’ll get back to this point in the second motivation to resist change on the part of VCs.
- Exit. Having Tiger as an investor signals to the market that you’ll have to pay a high price to buy the asset. So far I have not seen any backlash on that front, but it may be too soon to tell. Crunchbase lists 36 exits announced since January 2021 in which Tiger was a top 5 investor. That’s 30% of all the exits attributed to Tiger on the platform in total
VC firms going for the Tiger strategy may quickly find themselves in negotiation rounds with their LP base about their compensation. Tiger doesn’t seem to have the same limitations.
I’ll soon stream a live webinar on how Tiger is able to finance itself, so make sure you sign up for the newsletter (see the box at the end of this post) and follow us on LinkedIn to get the notification when we do.
Internal Motivations
One of Clayton Christensen’s most brilliant insights in the Innovator’s Dilemma is finding the motivations of managers leading incumbents disrupted by new entrants. His ability to juggle both the macro and the micro is what makes him such an original researcher. The Harvard professor has been repeatedly ranked among the best researcher in the world and even inducted in the Thinkers50 Hall of Fame in 2019 (yes, academics have their own version of it).
“Why do market leaders disappear?” is the question at the root of his Disruption theory. Most people would answer: “Because their leaders are incompetent, complacent, or prudent”. Christensen refutes this hypothesis. He demonstrates that those managers—many of them, he jokes, Harvard-educated—are failing despite applying state-of-the-art business thinking and techniques.
Leaving a market segment at the bottom that is not profitable to a new entrant willing to get those customers makes financial sense, as margins immediately improve. Managers are trained to make decisions that improve their career prospects, he argues. Additionally, they are obsessed with the mantra that “the customer is king”, which pushes these market leaders to add features to products at the detriment of their price. I’ll detail how the Disruption theory works in my live webinar “Is Tiger Global good for Venture Capital?“, as it would be too long to do it here.
This is one of the innovator’s dilemmas: Blindly following the maxim that good managers should keep close to their customers can sometimes be a fatal mistake.
Clayton Christensen – The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail
This dynamic (“I will make decisions that are good for my career even though they may ultimately lead to my firm’s annihilation”) is due to external motivations. I just described how they apply in the VC world: “I’m not going to do diligence-light deals at high valuations with no Board seats as it will endanger my compensation”.
Venture Capital was born when a group of savvy financiers and former entrepreneurs banded with talented innovators to create great companies. This first wave of Venture Capitalists, such as Arthur Rock, Tom Perkins, and Don Valentine, were adding tons of value to the firms they invested in. The best testament of these early days is the 2011 documentary Something Ventured.
However, these days are long gone. As I claim in my webinar Do Venture Capitalists Take Enough Risks?, most Venture Capitalists today are money-managers trying to get on the hottest startups by networking with other VC firms, not first-principle analysis. Very few have an operational background, let alone an entrepreneurial one.
“80% of Venture Capitalists Add Negative Value To Startups”
Vinod Khosla (source: click here)
Only a handful of—mostly early-stage—VCs can argue that they truly add value to the startups they invest in. It is not difficult to imagine that for the others, Tiger’s approach is tremendously anxiogenic. The cross-over funds have shown that there is no dearth of successful Founders who do not consider, or want, VC’s help. Just their money.
If you operate in a job with the illusion that what you’re doing is good for others, which I have no doubt most VCs genuinely believe, such a wake-up call will destroy your self-esteem. And we know where that leads, a long path towards depression and other forms of mental strain.
Denial is a common defense we use to protect ourselves. Getting out is another, as Keith Rabois, another Founders Fund self-proclaimed contrarian, predicts. The Tiger approach may prove the proverbial drop that pushes VCs who made good money in past years to retire.
I would expect an accelerated wave of VC retirements.
— Keith Rabois (@rabois) December 3, 2021
It seems that Julian Roberston’s lesson with Coleman has sprung a new trend disrupting Venture Capital. Let’s see how high the wave goes.
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