The Founder is dead. Long live The Founding Investor.
2020–12–30
The past decade has seen a relentless shift in startup power dynamics from labor to capital.
Startup founders have been among the most admired self-made capitalists of the 21st century. These visionaries have been able to see glimpses of the future, creating new products, markets, and business models, often based on novel technologies, and creating vast amounts of wealth and productivity in the process. Many have been young, naïve, and very very lucky to have captured lightning in a bottle, and most have taken considerable personal and professional risk along the way.
Building a successful company, from concept to multibillion-dollar empire, has always involved partnership with investors; it takes huge amounts of capital to rapidly scale a business, and most early-stage companies will operate at a loss for years. The balance of power has typically depended on the cost and availability of capital, the specific vertical, and the effectiveness of the management team at fundraising and executing on the business plan. Things have changed.
The founder is no longer the main character in the story.
Federal interest rates and treasury yields have been at record lows for almost a decade. As a result, cash has been plowed into asset classes typically viewed as riskier, including public equities, which continue to defy reality, and venture capital. Fund sizes have grown and, as I have pointed out before, so have the size of venture financings, effectively raising the bar for access to institutional investment.
Venture capital has always been a strange business, with returns concentrated in a handful of funds and, within those funds, typically driven by the ability to double down on a handful of ultra-high performing companies. The best venture investors have historically been able to spot the diamonds in the rough, or have just plain gotten lucky. The Midas list is typically a negative indicator for following year fund performance.
But waiting for the stars to align on an investment opportunity creates inefficiency for fund managers. Rather than spending years searching for the perfect combination of founding team, technology, and market opportunity, fund managers (many of them former founders) have increasingly taken matters into their own hands. The magic and randomness has been removed from startup creation, replaced by ruthless and highly effective new models.
Flagship and Third Rock were among those who pioneered the venture creation model for biotech in the Boston/Cambridge ecosystem. It goes like this: recruit a boiler-room full of brilliant PhDs to scour scientific literature and pit them against each other in a Lord-of-The-Flies-style pressure test until the most impactful science (not stabbed full of holes by pointy sticks) rises to the top. At this point, early venture investment is brought to bear to run some very early hypothesis testing. Valid reproducible innovations get VERY LARGE Series A financings and a veteran management teams with pharma pedigree. This is how Moderna got its start in 2010, as well as many other successful companies. The model has the benefit of giving the venture fund near-complete ownership of the operating company on day one. The actual founders are typically salaried associates, and will stay that way.
A related model has seen venture funds directly partnering with universities to get early access to breakthrough science. Deerfield has been especially adept at forming these alliances as has Osage and others. These university-fund partnerships are formed to give specific funds an unfair advantage in exchange for limited research sponsorship. The venture funds have no interest in university scientists as founding management teams; they simply want to get their hands on the best innovative science.
Hired guns.
The models above reduce the messiness of startup formation to a reproducible formula, and they are working. More companies are getting to large exits (M&A and IPO), more breakthrough platforms are being developed, and more medicines are reaching patients. Innovative and impactful science is having its moment, and fund returns are reflecting this success, in part driven by the willingness of public markets to provide capital for late-stage clinical development.
The rise of the biotech SPAC (Special Purpose Acquisition Vehicle) has provided additional options for liquidity. The SPAC model is reminiscent of a scaled-up search fund so popular with trust-fund MBAs. Both SPACs and search funds are pools of capital looking for a company to take over, typically replacing management structures in the process. SPACs are especially popular with bankers due to rapid timelines and robust fee structures.
With more cash supporting more innovation, is there still a role for the founder-led startup within the broader biotech ecosystem? Founding management teams are typically fully committed to a new startup, living on hardship wages, and doing whatever it takes to make the business work. In biotech, these true believers have been largely been replaced with hired guns, willing to shut down the company at the first bump in the road. There is opportunity cost to consider, after all, both for the fund and for the hired management team. Better to redeploy capital and top-tier managers to a new portfolio company concept. Whether creating new operating companies internally or partnering with academic institutions, many funds have no need for a traditional founding team. The founder is a dying breed.
The future.
Entrepreneurship is being increasingly formalized. Top MBA programs now offer specific degree tracks and course offerings focused on starting a new high growth company. A generation of venture investors has now shown, in biotech and elsewhere, that a genius founding team is no longer integral to company success. The innovation industry has been professionalized.
In the future, we will see this model move into other industries. Biotech, with its massive capital requirements and lengthy development timelines, has always been a place where investors have outsized control early on. But hard tech, SaaS, enterprise software, even consumer tech…these investors can and will follow suit. The ability to bring the right team to bear on the right problem with the right technology and the right capital base is what matters. We will continue to romanticize the “organic” founder, who quits their day job and sacrifices for their dream, but in the current innovation ecosystem, this is a fantasy. The role of the passionate founder is dead. Long live the founding investor.