VCs Outside the Valley Play a Different Game

Andy Rachleff, the founder of Benchmark Capital and Wealthfront, has a new article up titled Demystifying Venture Capital Economics, Part 3. The main point of the post, which isn’t well understood, is that many technology markets are winner-take-all such that most of the venture capital returns flow to the firms that invest in the market winners — most other investments result in a loss or modest gain. Here are a few choice quotes from the article:

• In fact, first to market seldom matters. Rather, first to product/market fit is almost always the long-term winner.
• The premier venture capital firms compete vigorously to back the Gorilla because they know the market leader is ultimately worth more than all the Chimps and Monkeys combined.
• Every market appears overfunded, but the ultimate value of the Gorilla consistently swamps the total capital invested in the space.
• Not only will that Gorilla generate huge returns for its investors but its ultimate market value will be far greater than all the money you feared had been invested in a bubble.

So, the name-brand VCs in the Valley are looking for the Gorillas/Unicorns (billion dollar companies) and rarely do billion dollar startups emerge outside the Valley, VCs outside the Valley must be playing a different game. That is, VCs outside the Valley aren’t looking to have one investment return the fund. Rather, the goal is to generate a 15-20% rate of return each year by investing in startups that exit for significantly less than a billion dollars at much lower initial investment valuations.

When people talk about recruiting top-tier VCs to open an office in their city, they likely don’t understand their city doesn’t play the same type of VC game as the Valley. Now, one type isn’t necessary better than the other — they just have different priorities.

What else? What are some more thoughts on the idea that VCs outside the Valley play a different investing game?