Venture Studios Aren't in the Business of Building Ventures, They're in the Business of Exiting Them
Venture studios win by driving cash on cash returns, ideally faster than typical investors. (#97)
Venture studios build and fund startups. That’s their job. Given the rigor many of them use to test ideas & validate opportunities, they’re supposed to build successful startups faster and generate better returns. That’s what early data suggests. I believe the data, but it’s important to note that it’s self-reported, presumably by those that are proving the thesis.
Venture studios spend a lot of effort on how to systematically validate and build startups. Every studio has an extensive methodology, which they’ll argue is part of their proprietary value proposition. Proprietary or not, following a thorough validation process for picking new startup ideas and building them makes sense. It increases the odds that you validate the riskiest assumptions first, focus on what matters and point new startups in a good direction.
But winning for a venture studio isn’t at the startup creation phase, it’s when there’s liquidity.
Ultimately, the only thing that matters for a venture studio is cash on cash returns.
If you want to prove the value of a venture studio, don’t focus on the beginning, focus on the end.
Venture studios need to be masterful at manufacturing exits.
The power of early exits
While it’s completely reasonable to chase billion dollar exits that typically happen ~10+ years after a company is created, many venture studios will win based on smaller, early exits. The “rinse and repeat” strategy to building startups lends itself to this approach. Done properly, early exits—with a higher degree of frequency—can be very meaningful financially for studios and their investors.
If a venture studio builds a bunch of startups and none exit, it’s a failure.
If a venture studio builds a bunch of startups and gets one big exit to pay for all the others, I don’t think it survives financially, b/c it takes too long and the studio will struggle to pay its bills and raise new capital (i.e. Fund II after Fund I, etc.)
The capital requirements for building a startup are dropping, thanks to the explosion of AI tooling and the infrastructure venture studios have. This opens up the possibility of being less dependent on significant downstream capital.
Venture studios can build a new startup for ~$250-$500k (software, not necessarily hardware or deeptech);
Startups can get meaningful traction with a small team at a relatively low cost (thanks to AI & automation);
Startups don’t need to raise huge sums of capital later (although they can);
Therefore, early exits with the studio + founders owning healthy chunks of the cap table make a lot of sense.
How can venture studios drive successful exits?
Go vertical.
A vertical venture studio is designed to build a close network of stakeholders in a narrow industry to better identify:
The pain points that exist
The early design partners / beta customers
The co-investors interested in the space
The industry players that may be great partners for validation, brand building, distribution, etc.
The acquirers
Once you have the “full stack” of partnerships within the ecosystem, it becomes much easier to identify whitespace and partner with key players to drive early momentum and ultimately, liquidity.
For example:
You could partner with private equity firms to identify gaps in their portfolio;
You could partner with a family office that owns businesses or has investments in certain verticals;
You could partner with a big corporate that’s looking to explore opportunities beyond their core, which they might want to acquire in the future.
The key is meaningful partnerships that give you, as the venture studio owner, privileged access to resources you otherwise wouldn’t have. Each of these stakeholder groups can provide validation that you’re on the right track and expedite the process of scaling.
A good proxy is vertically integrated e-commerce. In this case (think Warby Parker, Casper, and Glossier) the companies own most or all of the supply chain from manufacturing to selling (usually online, but also retail). For e-commerce companies, they often expand beyond their own retail stores at some point, but they still control the bulk of the supply chain in comparison to other brands that do much less.
Vertical venture studios don’t own the entire “startup lifecycle stack” (i.e. they’re not the builder, scaler and acquirer!) but they need to be deeply connected into every stakeholder. It comes down to who you know, and how you leverage that.
How to execute a vertical venture studio strategy
Here are 6 steps to creating a vertical venture studio:
1. Define the right vertical
First, pick the vertical you want to enter. Don’t make it too broad, because it’ll be difficult to line everything up, including a strong group of design partners, corporate partners, go-to-market channels, etc. In some respects, the narrower, the better. It’s possible you go too narrow, but I’d lean in that direction.
You’ll find more success if every startup you build targets the same customer type with the same GTM motion and business model. The playbooks you’re using to build startups are very precise and get better every time you build a new company.
2. Secure domain expertise
You cannot build a vertical venture studio without domain expertise. If you have it, fantastic! If not, get a partner. The partner could be an individual, company, private equity firm, family office or someone else. Ultimately you need someone with “insider information” (in a good way) that understands the industry, its pain points, challenges, etc.
I like the idea of balancing domain expertise with non-experts (which may be the founders you bring in to run the startups), so you don’t get overwhelmed by the inevitable baggage that comes from expertise. If you’ve spent 5-10+ years in a space, you have baggage (the “curse of knowledge”), which can weigh things down. But without domain expertise, you’re flying blind and it’ll take much longer to build the necessary reputation and relationships.
3. Design the studio
Next you need to design the studio. This is true whether you go after a vertical or not. I’ve put together a comprehensive checklist with 60+ questions/variables that you’ll need to deal with:
4. Build deep relationships
A vertical studio only works if you know “everyone” in the vertical, from users/customers to acquirers. You may already have these relationships, or some of them, but you’ll likely need more. You need to be in constant contact with all the key players, identifying pain points / white space, promoting your portfolio, connecting dots and creating value.
This is the key unlock to the vertical venture studio strategy. You need to be at the epicentre of the vertical.
5. De-risk your first venture as much as possible
The first startup out of your venture studio should be something that you’ve pre-vetted with users/customers, co-investors, and key industry leaders (i.e. PE firms, corporates, etc.) You want the first startup to rush out of the gates with as much industry support as possible. The more you can tee up for the first startup, the better.
This is where the potential of an early exit is very interesting. You can’t necessarily guarantee an exit with a pre-determined acquirer, but how can you make the path as straight and clear as possible from startup creation to startup exit? Ideally the first startup leaving your venture studio has a clear path towards acquisition, because you’ve designed it that way.
Being able to show cash on cash returns quickly (say within a few years) versus the standard (7-10+ years) can go a long way to establishing credibility, and helping you raise further capital.
6. Rinse and repeat
Venture studios only work when they repeatedly build and fund quality companies. After you launch startup #1, you move to startup #2, then #3, #4, etc. Most studios target 2-6 startups/year—it’s not a high volume game—which is even more reason to bring as many assets / ingredients to the table as possible early on.
De-risking isn’t just about validating the problem and solution with users/customers (although this is where venture studios spend most of their time).
De-risking in a vertical venture studio is about lining up the right investors, partners and acquirers. That’s where a studio can have maximum impact.
Launching vertical venture studios at Highline Beta
At Highline Beta, we’ve recently launched two vertical venture studios: DentalTech and ETH. We call this updated strategy, Highline Beta 3.0.
DentalTech is focused on solving pain points for dental clinics with software. We’re working with great partners (domain experts with deep networks), and we’re building the GTM & business model playbooks. This is a narrow, but big vertical market that has growing interest from investors and PE firms. Our first portfolio company is DentalForce (solving temporary staffing challenges for clinics).
ETH is focused on B2B uses cases leveraging Ethereum, blending TradFi & Web 3 ecosystems. Our initial focus is wealth management. Again, we have great domain experts as partners (such as Nigel da Costa and Dima Buterin) and we’re quickly building our network. This is a broader vertical, but we’re working on narrowing it as we validate venture opportunities.
If you’re interested in either of these, let me know.
Going forward, the bulk of startups we build and fund will emerge from our vertical venture studios. We’re going deep versus wide, because we believe this will generate the best returns for our investors (and us).
Venture studios build and fund startups at inception. It’s a compelling model that’s gaining popularity because people see the potential of de-risking early and helping startups execute faster.
But remember: no venture studio wins because it builds startups. That just gets you in the game. Venture studios only win when their startups exit. We should see more venture studios investing in the relationships, network and capabilities to drive (early) exits as part of their value proposition.
Is it common that in B2B prospective investments you're presented w/ a 0-to-1 innovation that requires a B2C prototype , with real world traction, before rolling out as a B2B solution. If not common, is it plausible/acceptable *or* would the best practises suggest culling out such ideas?