Andreessen Horowitz, and the Rise of “Venture Banks”

In 2009, Andreessen Horowitz raised a brand-defining fund. The plucky EMs — on a mission to steamroll the Benchmark model of VC — are believed to have delivered >5x for LPs from AH Fund I.

Much of their founding story is at-odds with how the firm is perceived today, as a large and undisciplined agglomerator.

Describing their strategy in 2009, both Andreessen and Horowitz clearly had a grasp of managing risk with portfolio strategy at early stages. Their intent was to spread capital across a wide base of early opportunities, doubling-down on the strongest amongst them:

"First, they’re going to spray small amounts of their first fund — checks of around $50,000 to $100,000 — into between 60 and 80 early stage companies. [...] Next, they’ll invest between checks of several million dollars into 12 to 15 more advanced companies, which typical for venture capital firms"

(source: "Web pioneer Andreessen raises $300M for new venture capital firm")

From the beginning, the pair had talked about being multi-stage oriented:

"We want to be in business with the best entrepreneurs going after the biggest markets and we do not care whether they need seed money, venture money or growth money."

(source: "Ben Horowitz: Why Andreessen Horowitz Just Raised $650,000,000")

However, they were also cautious about the influence of bloat on fund performance:

"We do not want the fund size to dictate our investment pace. We have seen other firms raise so much money that they lower their quality bar in order to “put the money to work.” We would strongly prefer to run out of money sooner and be forced to raise a third fund than to have that problem."

(source: "Ben Horowitz: Why Andreessen Horowitz Just Raised $650,000,000")

"It is a fact that capital invested is negatively correlated with returns in the venture capital industry. Pumping too much money into a small start-up is unhealthy for both the company and the investor."

(source: "The Case for the Fat Startup")

And whether they were following the data or were just operating on instinct, they had a sense that founder-led companies outperform:

"Marc and I share a simple belief that became the basis for our new venture capital firm: in general, founding CEOs perform better than professional CEOs over the long term, and a venture capital firm that enables founding CEOs to succeed would help build the best companies and yield superior investment returns."

(source: "Why Has Andreessen Horowitz Raised $2.7B in 3 years?")

In many ways, their strategy in the beginning appears to have been informed by their experience as angel investors — and in many ways is close to the ideal for venture capital:

• Hunting the best looking opportunities with minimal constraints on what companies qualify.
• A properly diversified portfolio, to reduce concentration risk and maximise hit rate.
• A single-trigger model where partners can make investments without consensus.
• Backing founder-led companies and focusing mentorship on helping them be effective CEOs.

These factors led to their initial success in a difficult post-GFC market. Indeed, Andreessen Horowitz was the only one of today's top 10 firms (by funds raised this year) to raise a fund in 2009.

In the years following, the performance of Andreessen Horowitz' subsequent funds appears to have tailed off. While this is common for VC in general, I think in Andreessen Horowitz' case it's also a matter of circumstances in the market — and was perhaps even calculated.

Consider the following:

In 2009, Andreessen had described their strategy for small checks based on 'the belief that a new wave of startups building with inexpensive web tools can get by with less than $500,000 in total funding over the lifetime' — to quote the VentureBeat article.

Just a year later, in 2010, things had clearly shifted and the sentiment from Horowitz was rather different:

"Winning the market and not running out of cash. Running lean is not an end. For that matter, neither is running fat. Both are tactics that you use to win the market and not run out of cash before you do so. By making “running lean” an end, you may lose your opportunity to win the market, either because you fail to fund the R&D necessary to find product/market fit or you let a competitor out-execute you in taking the market. Sometimes running fat is the right thing to do."

(source: "The Case for the Fat Startup")

In one leap, after just one fund, the firm had gone from portfolio discipline and performance-oriented investing, to doubling their fund size and pushing startups to spend more on growth. Much more aligned with the Andreessen Horowitz we know today, and the 'growth at all costs' era that would soon follow.

There are a number of possible causes for this, but it is striking that 2010 had been a blockbuster year for large venture funds. Andreessen Horowitz, General Catalyst, Northwest Venture Partners, Tiger Global, Kleiner Perkins and IVP are amongst those who raised >$600M funds that year, with combined share of 32% of venture funding. This is a level of concentration we would not see again until this year.

2010 marked the return to dotcom-sized $1B+ funds, which had since been painted as a mistake in an asset class that couldn't easily scale — or so we were told by firms like Benchmark:

"Everyone said them back in 2002 or so, when nearly every $1 billion fund was “right-sized,” management fees were returned to investors and general partners sheepishly admitted that the venture business was a boutique industry that just doesn’t scale. The difference is that Gurley and Cohler are still saying it at a time when many of their peers seem to have swung back to we-can-do-it-all extremes."

(source: "Benchmark Capital's Stand: We Will Never Do a Seed or Late Stage Fund")

This huge injection of capital came as web and mobile were hitting new heights, and new advertising and social media models were powering the hyper-scale growth of digital startups.

"Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale."

(source: "Why Software Is Eating the World")

In the decade that followed, a lot of venture capital activity would become effectively zero sum, or even negative sum. Capital went from a competitive advantage to a weapon:

"First, venture capitalists (VCs) provide a startup—the “venture predator”—with cash for predation. Second, the venture predator uses that cash to price its goods or services below cost, grab market share, and drive its rivals out of the market. Third, once the venture predator dominates the market, its VCs—and often its founders—cash out by selling their shares to investors who believe that the company can recoup the costs of predation."

(source: "Venture Predation")

In this environment, it wasn't just Andreessen Horowitz who would see returns suffer — every growth investor would experience something similar. The new game on the field for VC was not just to finance novel solutions with market-defining potential, but (in a world of more easily replicated software) to ensure they weren't smothered by a late-joining competitor with more cash to fuel more aggressive growth.

I suspect that Andreessen and Horowitz looked at this reality, and saw two paths forward:

1. Venture Capital becomes a more tightly regulated industry, with scrutiny on predatory and anti-competitive practices.
2. Venture Capital taps into new sources of LP capital, growing dramatically in AUM and velocity, even if that creates a drag on returns.

Obviously, the second option was more appealing to successful venture investors with a libertarian skew.

The mistake that many critics have made, myself included, is to believe Andreessen Horowitz hacked VC by pursuing larger LPs with a lower bar for returns just to maximise their fee income.

The fees are important (certainly everyone associated with the firm has done very well financially), however, they were a means to an end: Scaling income means expansion, expansion means stability, trust and status — eventually appealing to even the largest sovereign wealth funds. Thus, "venture bank" has become a fitting moniker for firms at this scale.

There have been growing-pains as the multi-stage model diverged in size and strategy from traditional VC. As it has pulled away from the main venture market, it has warped pricing, damaged trust, and hurt returns. This has created some resentment from other GPs. However, the most optimistic case is that this is temporary.

This leads, I believe, to the bifurcation we've all been talking about through 2024. Smaller, nimble and contrarian funds will continue to play an important role, but later stage growth capital is increasingly going to be dominated by agglomerators like Andreessen Horowitz.

In theory, that is ok — maybe even a logical evolution, although I wonder what it means for exit timelines. Will public market investors ever get an opportunity like Google or Facebook again? Long term, if they are shut-out of sharing in that growth and prosperity, what does that do to public sentiment towards tech and VC? In important concern, albeit a vague one.

However, there are two more pressing questions:

Why does Andreessen Horowitz still invest at Seed?

Their seed investing today (as reflection of their 'big ideas' manifesto) feels like an ideological attempt to shape the market, when you look at the scale of their AUM and range of investment categories. In 2009, they had a thesis about where the market was headed (the potential in "web tools") but I doubt they would have imagined publishing a list of ideas they wanted to invest in, or trying to manifest particular themes. As small investors, looking to deliver performance, they simply looked for the best founders building the most important ideas — whatever they may be. Without minimal constraint.

I understand the role that Andreessen Horowitz played in turning the VC industry towards themes like defense, with their Anduril investment in 2017. The correction of a negative bias is great, but it becomes equally problematic when that overcorrects into positive bias. This is the kind of heat-generating behaviour the firm used to get to reach its grand scale today, and I would hope becomes less necessary in future.

What are the incentives of Andreessen Horowitz (and other large firms) investing as an LP in smaller VCs? This question really doesn't get asked often enough.

• The steelman case: It's intended to strengthen the early stage venture market in a way that provides a foundation for their increasingly growth-stage orientation. They believe the data showing independent small funds and EMs outperform, and so offer capital with no strings attached.
• The strawman case: They are embedding their influence across an increasingly captured market of networked GPs, who are heavily encouraged to invest in themes that Andreessen Horowitz supports. In doing so, they are increasingly channelling capital and deal flow away from competing firms.

Each of these positions has supporters and detractors in the venture industry. Some more vocal than others. The first group look at the origins of Andreessen Horowitz as a truly founder-friendly firm. The second look at their less ethical investments as proof of a lack of morality in their mission.

On one hand, Andreessen Horowitz (and the other "venture banks") have helped pull a vast amount of capital into venture, from a new class of LPs. Perhaps this was necessary, to fund the most profound technological developments? However, is it ultimately just replacing public markets with more private capital as a means to avoid scrutiny?

On the other hand, they are certainly a major player in a market shift that has been catastrophic for VC returns over the last 20 years. However, maybe this is just a (relatively) short-term dip as the whole venture market matures and settles into this more efficient bifurcated structure?

Not many helpful answers here, although none of this really changes my opinion about the need for...

• More significant tax incentives for smaller firms.

• Increased scrutiny of the largest firms that are investing "public" money — and the companies they invest in — in part to make staying private less appealing.