A16z Partner's Self-Description: Boutique VC is Dead; Scaling Up Is the Ultimate Goal for VC

The Case for Scaling Venture Capital by Erik Torenberg, a16z

Source:

Reprinted from Mars Finance

Deep Tide Introduction:

In the traditional narrative of venture capital (VC), the “boutique” model is often celebrated, with the belief that scaling would dilute the soul. However, a16z partner Erik Torenberg presents a counterpoint: as software becomes the backbone of the U.S. economy and with the advent of the AI era, startups’ demands for capital and services have fundamentally changed.

He argues that the VC industry is shifting from a “judgment-driven” paradigm to a “transaction-winning” capability-driven one. Only large institutions like a16z, with scalable platforms capable of providing comprehensive support to founders, can succeed in a trillion-dollar game.

This is not just a mode evolution but a self-innovation of the VC industry amid the wave of “software devouring the world.”

The full text is as follows:

In ancient Greek literature, there is a meta-narrative above all others: respect for and disrespect toward the divine. Icarus was burned by the sun, not primarily because of his ambition, but because he disrespected the sacred order. A more recent example is professional wrestling. Just ask, “Who respects wrestling, and who disrespects wrestling?” and you can distinguish the heroes (Faces) from the villains (Heels). All good stories take this or that form.

Venture capital (VC) also has its own version of this story. It goes like this: “VC has always been, and still is, a boutique business. Large institutions have grown too big, with goals too high. Their downfall is inevitable because their approach is a blatant disrespect for the game.”

I understand why people want this story to hold. But the reality is, the world has changed, and so has venture capital.

Today, software, leverage, and opportunities are greater than ever. The number of founders building larger companies has increased. Companies stay private longer than before. And founders’ expectations of VCs are higher. Today, the best founders need partners who can truly roll up their sleeves and help them win, not just write checks and wait for results.

Therefore, the primary goal of VC firms now is to create the best interfaces to help founders succeed. Everything else—how to staff, how to deploy capital, how large a fund to raise, how to assist in closing deals, and how to allocate power to founders—is derived from this.

Mike Maples has a famous saying: “Your fund size is your strategy.” Equally true is that your fund size reflects your belief in the future. It’s a bet on the scale of output from startups. Raising huge funds over the past decade might have been seen as arrogance, but fundamentally, this belief is correct. So when top institutions continue to raise massive amounts of capital to deploy over the next decade, they are betting on the future and backing their commitments with real money. Scaled venture capital is not a corruption of the VC model; it is the model maturing and adopting the characteristics of the companies it supports.

Yes, VC firms are an asset class.

In a recent podcast, Sequoia’s legendary investor Roelof Botha offered three points. First, despite the growth in VC size, the number of “winners” each year remains fixed. Second, the scaling of the VC industry means too much capital chasing too few great companies—thus, VC cannot truly scale; it is not an asset class. Third, the industry should shrink to match the actual number of winners.

Roelof is one of the greatest investors ever and a good person. But I disagree with his view here. (Of course, it’s worth noting that Sequoia itself has scaled: it’s one of the largest VC firms globally.)

His first point—that the number of winners is fixed—is easily falsifiable. Ten years ago, about 15 companies had revenues of $100 million annually; now, that number is around 150. Not only are there more winners, but their scale is larger. Although entry prices are higher, the output is much greater than before. The growth ceiling for startups has risen from $1 billion to $10 billion, and now to $1 trillion or more. In the 2000s and early 2010s, companies like YouTube and Instagram were considered billion-dollar acquisitions—so rare that we called companies valued at $1 billion or more “Unicorns.” Today, we directly expect OpenAI and SpaceX to become trillion-dollar companies, with several others following.

Software is no longer a fringe sector of the U.S. economy composed of oddballs. Software is now the economy. Our largest companies and national champions are no longer General Electric or ExxonMobil but Google, Amazon, and Nvidia. Private tech companies now account for about 22% of the S&P 500. Software has not finished devouring the world—in fact, with AI-driven acceleration, it has only just begun—and it is more important than 15, 10, or 5 years ago. Therefore, the scale a successful software company can reach is larger than ever.

The definition of “software company” has also changed. Capital expenditures have surged—large AI labs are becoming infrastructure companies, with their own data centers, power plants, and chip supply chains. Just as every company is becoming a software company, now every company is also becoming an AI company, or perhaps an infrastructure company. More and more companies are entering the atomic age. Boundaries are blurring. Companies are aggressively verticalizing, and these vertically integrated tech giants have market potentials far beyond what any pure software company could imagine.

This leads to why the second point—too much capital chasing too few companies—is wrong. Output is much larger than before, competition in the software world is fiercer, and companies go public much later. All these mean that great companies need to raise far more capital than before. The existence of venture capital is to invest in new markets. Time and again, we learn that in the long run, the scale of new markets is always much larger than we expect. The private markets are mature enough to support top companies reaching unprecedented sizes—just look at the liquidity available to today’s top private firms—and both private and public investors now believe that VC output will be enormous. We have consistently misjudged how large VC as an asset class can and should become, and VC is scaling to catch up with this reality and the opportunity set. The new world needs flying cars, global satellite grids, abundant energy, and cheap, almost immeasurable AI.

The reality is, many of today’s best companies are capital-intensive. OpenAI spends billions on GPUs—more than anyone imagined for computational infrastructure. Periodic Labs needs to build automated labs at unprecedented scale for scientific innovation. Anduril is building the future of defense. All these companies must recruit and retain the world’s top talent in a historically fierce talent market. The new generation of big winners—OpenAI, Anthropic, xAI, Anduril, Waymo, and others—are capital-intensive and have completed massive initial funding rounds at high valuations.

Modern tech companies often require hundreds of millions of dollars because building world-changing advanced technology is prohibitively expensive. During the dot-com bubble, a “startup” entered a blank slate, imagining the needs of consumers still waiting for dial-up connections. Today, startups are entering an economy shaped by three decades of tech giants. Supporting “Little Tech” means you must be prepared to arm David against a few Goliaths. In 2021, companies indeed received overfunding, much of which went into sales and marketing to sell products that didn’t deliver 10x returns. But today, capital flows into R&D or capital expenditures.

Thus, the scale of winners is much larger than before, and they need to raise far more capital—often from the start. So, it’s natural that the VC industry must become much larger to meet this demand. Given the size of the opportunity set, this scaling is reasonable. If VC size were too large for the opportunities it invests in, we would see poor top-level returns. But we don’t. As they expand, top VC firms repeatedly deliver multiples of 10x—so do their LPs (Limited Partners). A famous VC once said that a $1 billion fund can never achieve a 3x return because it’s too big. Since then, some funds have exceeded 10x on a $1 billion fund. Some point to underperforming firms to criticize the asset class, but any industry following a power-law distribution will have huge winners and long-tail losers. The ability to win deals without relying solely on price is what allows these firms to sustain consistent returns. Unlike other major asset classes, where products are sold or loans are made to the highest bidder, VC is a unique asset class where competition occurs across multiple dimensions beyond price. VC is the only asset class with significant and persistent top-tier players.

The last point—that the VC industry should shrink—is also wrong. Or at least, it would be a bad idea for the tech ecosystem, for creating more intergenerational tech companies, and ultimately for the world. Some complain about the second-order effects of increased VC funding (and there are some!), but it also leads to a significant increase in startup valuations. Advocating for a smaller VC ecosystem likely means advocating for smaller startup valuations, which could slow economic growth. This perhaps explains why Garry Tan recently said in a podcast: “Venture capital can and should be ten times bigger than it is now.” Certainly, if there were no competition and a single LP or GP was “the only player,” that might benefit them. But more VC funding overall is clearly better for founders and the world.

To illustrate further, let’s consider a thought experiment. First, do you think there should be many more founders in the world than today?

Second, if we suddenly had ten or a hundred times more founders (spoiler: this is happening), what kind of institutions would serve them best?

We won’t dwell too long on the first question because, if you’re reading this, you probably agree the answer is obviously yes. We don’t need to tell you much about why founders are so excellent and important. Great founders create great companies. Great companies develop new products that improve the world, organize and direct our collective energy and risk appetite toward productive goals, and generate disproportionate new enterprise value and interesting jobs. And we are far from reaching a balance where every capable person has already founded a great company. That’s why more venture capital helps unlock more growth in the startup ecosystem.

But the second question is more interesting. If we wake up tomorrow and the number of entrepreneurs is ten or a hundred times today (spoiler: this is happening), what should the startup ecosystem look like? How should VC evolve in a more competitive world?

Win big, rather than lose everything

Marc Andreessen likes to tell a story about a famous VC who said the VC game is like a conveyor belt sushi restaurant: “A thousand startups come around, you meet with them. Then occasionally you reach out, pick one off the conveyor, and invest.”

That’s how most VC operated—well, for most of the past few decades. In the 1990s or 2000s, winning deals was that easy. Because of that, the only real skill for a great VC was judgment: distinguishing good companies from bad.

Many VC still operate this way—basically the same as in 1995. But the world under their feet has changed dramatically.

Winning deals used to be easy—like grabbing sushi off a conveyor. Now, it’s extremely hard. Some describe VC as poker: knowing when to pick a company, at what price to enter, etc. But that may obscure the full-scale war needed to secure the best deals. Old-school VCs nostalgic for the days when they were “the only players” and could dictate terms to founders. But now, thousands of VC firms compete, and founders are more likely than ever to have term sheets from multiple sources. As a result, the best deals involve fierce competition.

The paradigm shift is that winning deals is becoming as important as picking the right companies—perhaps even more so. If you can’t get in, what’s the point of choosing the right deal? Several factors drive this change. First, the explosion of VC firms means they must compete with each other to win deals. With more companies competing for talent, customers, and market share, top founders need strong institutional partners to help them win. They need firms with resources, networks, and infrastructure to give their portfolio companies an advantage.

Second, because companies stay private longer, investors can participate in later-stage rounds—when companies are more validated—making deal competition even fiercer, yet still delivering VC-style returns.

The third, and least obvious, reason is that selecting deals has become somewhat easier. The VC market has become more efficient. On one hand, more serial entrepreneurs are creating iconic companies. If Elon Musk, Sam Altman, Palmer Luckey, or a talented serial founder starts a company, VCs will quickly line up to invest. On the other hand, companies reach massive scale faster (thanks to longer private phases and larger upside), reducing the risk of product-market fit (PMF). Finally, with so many great institutions, founders find it easier to contact investors, making it harder for others to get into deals. Selection remains the core—choosing the right enduring company at the right price—but it’s no longer the most critical factor.

Ben Horowitz hypothesized that the ability to repeatedly win deals automatically makes you a top firm: because if you can win, the best deals will come to you. Only when you can win any deal do you have the right to pick. You might not always pick the right one, but at least you have the chance. Of course, if your firm can repeatedly win the best deals, it will attract top pickers—those who want to get into the best companies (as Martin Casado said when recruiting Matt Bornstein to a16z: “Come here to win deals, not lose deals”). So, the ability to win creates a virtuous cycle that enhances your selection power.

For these reasons, the game has changed. My partner David Haber describes the necessary shift in VC as “Firm > Fund.”

In my view, a fund (Fund) has a single objective: “How can I generate the most carry with the fewest people and in the shortest time?” A firm (Organization), however, has two goals. One is to deliver outstanding returns; the other, equally important: “How can I build a source of compounding competitive advantage?”

The best firms will be able to reinvest their management fees into strengthening their moat.

How can we help?

I entered venture capital ten years ago and quickly noticed that Y Combinator plays a different game. YC can secure favorable terms with top startups at scale and also serve them at scale. Compared to YC, many other VCs are playing a commoditized game. I would go to Demo Day and think: I’m at a roulette table, and YC is the dealer. We’re both happy to be there, but YC is the happiest.

I soon realized YC has a moat. It has positive network effects. It has structural advantages. Some have said VC firms can’t have moats or unfair advantages—after all, they’re just providing capital. But YC clearly does.

That’s why YC remains powerful even as it scales. Some critics dislike YC’s growth; they believe YC will eventually lose its soul. People have predicted YC’s demise for over a decade. But it hasn’t happened. During that time, they replaced their entire partner team, and the firm still thrives. A moat is a moat. Like the companies they invest in, scaled VC firms’ moats are not just about brand.

Then I realized I didn’t want to play a commoditized VC game, so I co-founded my own firm and other strategic assets. These assets are highly valuable and generate strong deal flow, giving me a taste of a differentiated game. Around the same time, I started observing another firm building its own moat: a16z. So, years later, when the opportunity to join a16z arose, I knew I had to seize it.

If you believe in venture capital as an industry, you—almost by definition—believe in a power-law distribution. But if you truly believe that the VC game is governed by a power law, then you should believe that venture capital itself will follow a power law. The best founders will cluster around those institutions that help them win most decisively. The best returns will be concentrated there. Capital will follow.

For founders trying to build the next iconic company, scaled VC offers an extremely attractive product. They provide expertise and comprehensive support for every element needed for rapid growth—recruiting, go-to-market strategies, legal, finance, PR, government relations. They provide enough capital to truly reach the destination, rather than forcing founders to penny-pinch and struggle against well-funded competitors. They offer enormous reach—access to every key person in business and government, introductions to every major Fortune 500 CEO and world leader. They offer access to talent 100 times better, with a network of tens of thousands of top engineers, executives, and operators worldwide, ready to join when needed. And they are everywhere—for the most ambitious founders, that means anywhere.

Meanwhile, for LPs, scaled VC is also an extremely attractive product on the simplest question: are the most value-driving companies choosing them? The answer is straightforward—yes. All large firms partner with scaled platforms, often at the earliest stages. Scaled VC firms have more opportunities to seize key companies and more ammunition to persuade them to accept their investments. This is reflected in their returns.

Excerpt from Packy’s work:

Think about where we are right now. Eight of the top ten companies in the world are headquartered on the West Coast and backed by venture capital. Over the past few years, these companies have generated most of the new enterprise value globally. At the same time, the fastest-growing private companies worldwide are also mainly West Coast VC-backed firms: those founded just a few years ago are rapidly approaching trillion-dollar valuations and the largest IPOs in history. The best companies are winning more than ever, and they are supported by scaled institutions. Of course, not every scaled firm performs well—some epic failures come to mind—but almost every great tech company has backing from scaled institutions.

Go big or go refined

I don’t believe the future is only scaled VC firms. Like all areas touched by the internet, venture capital will become a “barbell”: one end with a few ultra-large players, and the other with many small, specialized firms operating in specific niches and networks, often collaborating with scaled firms.

What’s happening in venture capital is exactly what happens when software devours the service industry. On one end are four or five large, vertically integrated service players; on the other, a long tail of highly differentiated small providers, built as industry is “disrupted.” Both ends of the barbell will thrive: their strategies are complementary and mutually empowering. We also support hundreds of boutique fund managers outside the big firms and will continue to do so.

Both scaled and boutique firms will do well; the trouble is in the middle: funds that are too big to afford missing out on huge winners but too small to compete with larger institutions offering better products to founders. a16z’s uniqueness lies in being at both ends of the barbell—it’s a collection of specialized boutique firms, yet benefits from a scalable platform team.

The firms that work best with founders will win. This might mean enormous reserve capital, unprecedented reach, or a vast complementary services platform. Or it might mean unmatched expertise, top-tier consulting, or simply incredible risk tolerance.

There’s an old joke in venture: VC believes every product can be improved, every great technology can be scaled, every industry can be disrupted—except their own.

In fact, many VCs dislike the existence of scaled VC firms. They think scaling sacrifices some of the soul. Some say Silicon Valley has become too commercialized, no longer a haven for misfits. (Anyone claiming the tech world has enough weirdos clearly hasn’t attended San Francisco tech parties or listened to MOTS podcasts.) Others resort to a self-serving narrative—that change is “disrespectful to the game”—ignoring that the game has always served founders and always will. Of course, they never express the same concern about their own portfolio companies, which are built on the premise of achieving massive scale and changing industry rules.

Saying scaled VC isn’t “real venture” is like claiming NBA teams shooting more threes aren’t playing “real basketball.” Maybe you disagree, but the old rules no longer dominate. The world has changed, and a new model has emerged. Ironically, the way the rules are changing here mirrors how startups supported by VC change their industries. When technology disrupts an industry and new scaled players emerge, some things are lost—but many more are gained. Venture capitalists understand this trade-off—they’ve always supported it. The disruption they seek in startups applies equally to venture capital itself. Software is devouring the world, and it certainly won’t stop at VC.