The Challenge for Venture Studios

Venture Studios are an innovative approach to venture capital which aim to reduce investor risk by producing startups with an increased rate of survival and success, and doing so while achieving economies of scale – sharing a pool of resources between ventures, such as fractional support for generic functions like marketing, HR, finance, legal, and sales.

While venture studios adopt a range of models, with a significant amount of experimentation still going on with the format, there are two main categories:

• Corporate venture studios are – as the name implies – an extension of corporate venture capital, whereby a corporation will look to use a venture builder as a quasi-external innovation department. This allows the corporation to hedge against innovation in a cost-effective manner, with options to either incorporate successful ventures into the parent company, or spin them out. This can be carried out without risk of damaging their core brand, should things go awry. All funding comes via the corporation, negotiated based on milestones accounting for growth of portfolio companies, incurred costs and implied potential.
• Private venture studios are typically attached to a fund raised from LPs, in much the same way than a venture capital firm may operate. While private venture studios do not have the baggage associated with corporate backing, they also therefore lack the strategic purpose – and rely solely on the promise of future returns. While some may charge fees for services provided, a venture studio’s operations are financed primarily by management fees from the fund, which in venture capital are typically around 2%. Some venture studios may allocate a part of that fund to the venture studio itself.

In both cases, there is an opportunity to reach liquidity more quickly than the venture capital standard by spinning-out ventures as independent legal entities and selling stock to external investors or acquirers. As venture studios “earn” their equity via services and support provided, starting out with a large amount of relatively ‘cheap’ ownership (15-80%, depending on the model), it can make sense to cash-in sooner and reinvest the capital in new ventures.

For a more detailed look at the various structures and business models employed by venture studios, there are great articles by John Carbrey of FutureSight, and Ben Yoskovitz of Highline Beta which dive deeper into the revenue models, potential returns, fund types, etc.

Key challenges to address

The major challenges for venture studios both relate to their promise to deliver performance and the efficiency provided by cost-effective infrastructure.

• Cost Management: Whether they are corporate or private, venture studios are giving investors the promise of efficiency through economies of scale as the primary driver of ROI. This means they have to run particularly lean, as they compete with other cost centers for corporations or persist on just a percentage of their fund (e.g. for a $150M fund, they would have a budget of just $3M/year).
• Performance Tracking: Early stage venture capital typically operates on around a 10 year horizon to liquidity. For a venture studio, where spin-outs are more attractive for secondary liquidity earlier, this may be reduced to four or five years – but that still represents a long period before the value of a startup is realized by the market. This, with the pressure to deliver efficiency, means venture studios need a way to assure their backers that progress is being made, and the portfolio ventures are growing in value. A notoriously difficult challenge in opaque private markets.

The combination of these two factors makes many traditional means of measuring growth in value (such as 409a valuations) challenging. Venture studios need to deliver regular reports, often even quarterly, which reflect their growth in a standardized and transparent manner. This can be complicated further by the need to value projects at varying stages of development, including prior to their incorporation as separate legal entities and before they begin generating revenue.

Additionally, where private venture studios look to fund operations through equity investment as a part of the fund they raise, they also then need to calculate a valuation for the venture studio itself. This is a fairly complicated operation which may require projecting out future liquidity events plus any other revenue streams being built into the studio’s model.

Practical, systematic Startup Valuation for venture studios

Over the past few months we are working with an increasing number of venture studios to allow them to manage valuation and performance reporting to their backers on a regular basis, in a cost and time efficient manner. We are a strategic partner, helping these studios to navigate valuation while remaining lean and focused on their primary objective: scaling successful ventures.

The jury is out on whether venture studios truly provide a superior approach to startup creation, with concerns about founder ownership and buy-in weighed against the support and infrastructure offered to these early stage ventures. Regardless, we believe practical and systematic valuation has a key role to play in ensuring efficiency and performance for venture studios, as well as providing valuable data to help that model evolve and improve further.