Some problems with the VC-industrial complex

Venture capital can be great. And it has some structural challenges.

I’ve been reflecting recently on some of the problems with the current VC-industrial complex. There are many more, but I highlight three here:

(1) Exclusive focus on “power law” businesses;

(2) Inequity of capital allocation outcomes;

(3) Narrow concentration of the wealth created by fast-growing startups.

The Concentration of Power Law

Almost all Venture Capital is focused on “power law” returns. That is, the idea that a tiny number of huge winners will generate the overwhelming majority of returns. Uber, Facebook, Google, etc. Most VCs are exclusively chasing these power law businesses. If funds get into those businesses, they win. If they don’t, they lose.

So then the “TAM” (Total Addressable Market) is everything. If a startup is not operating in a market worth billions of dollars, and if the founder is not intent on building a billion-dollar business, then they’re not going to be interesting to VCs.

There are two problems with this power law obsession.

Firstly, the vast majority of businesses started in America every year do not fit this mold. They can never be billion-dollar businesses, the founder does not want them to be, and they should not try to be. But VC is so glamorized (dare I say fetishized), and it subsumes so much of the media coverage around startups / investing, that founders often feel like VC is their only option. Or at least, they feel like they should puruse venture capital funding. Sometimes it feels like the ultimate goal is “how much venture capital did I raise” — the means has become the end.

It is cool to see more and more founders bootstrapping these days. It feels like there has been somewhat of a mini rebellion against the VC-industrial complex from quarters like Indie Hackers, especially over the last few years since the 2022 downturn. This interview with the founder of Tableau is a beautiful articulation of a team building a huge company with minimal VC funding. Mailchimp is another example. And with Sam Altman’s suggestion that, in the not too distant future, AI will enable a founder to build a billion-dollar company without ever hiring anyone, this trend seems likely to grow.

But examples of founders that built unicorns without raising venture capital is not really my point here — the point is that the vast majority of companies are not a fit with power law investing. And on the other end of the spectrum, banks are only lending if there’s close to zero risk. There’s a massive gulf in the middle.

Some Revenue Based Financing solutions have emerged over the last decade or so (Pipe, Lighter Capital, Clearco, etc.). And more and more funds have started to experiment with investing in “smaller” businesses (Calm Company Fund, Indie VC, Novel GP, etc.). More innovations like this are needed, and welcome.

But overwhelmingly, the venture capital industry remains exclusively focused on power law businesses, and power law returns. This isn’t really “VC’s fault”. And it’s not “VC’s job” to construct and popularize a richer tapestry of investment structures that are more appropriate for a much wider range of startup “archetypes”. But the dominance of the power law paradigm is a big brake on startups raising the capital they need in 2025, and so a big brake on American economic growth, and dynamism.

The second problem with the preponderance of the power law is that, in order to get their hands on VC funding, startups contort themselves to look like a “power law company”, and oftentimes this can break the business. Facebook Ads are a dangerous drug. If you overdose on them too soon, you can get unhealthily addicted.

The story proceeds thus: Our startup founder hero has a nice startup going. It’s growing. Early customer adoption. But still a lot of work to be done in terms of refining the product, building the team, etc. But raising a venture round seems to be the done thing, and so let’s do it. But with that pile of venture money now sitting in the bank account, there is a lot of pressure to spend it to accelerate growth. So let’s spend it on customer acquisition (Zuck is delighted). Initially, this digital marketing spend keeps the growth going (through the Series B). But maybe these Facebook-acquired customer cohorts don’t perform quite as well (lower LTV, higher churn). And the size of the team grew a little too fast. And now the unit economics and diminishing returns start to catch up. And now it’s increasingly tough to raise the next round, especially in a market downturn like the one we’ve seen over the last three years.

Of course, it’s always the founder’s prerogative to swing for the fences. And if you want to hit a home run, VC funding is usually a great idea, and often essential. But too many founders are pressurized into taking venture capital because they feel like it’s the only option. Or because their perception of venture capital is over-rosily glamorized by its dominance of the media airwaves. (It’s quasi-amusing to me that the journalists who often seem to bemoan the VC-industrial complex often actually prop it up, by incessantly talking and writing about it).

And then when they take the VC dollars, they are often swept down a path that might not have been the right one, and ultimately breaks a business, which otherwise might have succeeded and endured.

I remember interviewing David Shaner, the founder of Offline, for our Adventure Capital podcast. He said something that stayed with me. He said he was raising capital from his customers in a community round (he raised $2M) because he wanted to preserve his optionality. He was potentially interested in raising venture capital for Offline in the future. He just didn’t want to commit himself to that path, yet.

We need more capital options for founders. This would mean more founders raise the capital they need to launch or grow their startups, and fewer companies are needlessly bankrupted by trying to force themselves to fit the power law pattern that they see as the only option.

Diversity, Equity and Inclusion

Uh oh. I said DEI. Shhhhhhh!!!!!!!! Please don’t cancel me!

But for all the recent backlash against the “woke mind virus”, I actually like these three words:

Diversity.

Equity.

Inclusion.

I, Jonny Price, wholeheartedly endorse, and stand behind, each of these three words.

DEI going out of fashion did not change the stats — that 1% of VC dollars currently goes to black founders, and 1% goes to Latino founders. And 2% goes to female-only founding teams, vs. 80% to male-only founding teams.

And by the way, if you don’t like DEI, let me cite this stat — 77% of VC dollars currently flow to three states, and they’re all Blue: California, New York and Massachusetts.

To me, the issue of DEI is similar to most other political tug-of-wars (tugs-of-war?!). Both sides are too extreme. The truth is somewhere in the middle. According to chatGPT, “as of 2023, approximately 14.4% of the U.S. population identifies as Black or African American”. Do we need to ensure that 14.4% of venture capital dollars goes to black founders? Or 85.6% of NBA players are Not Black? Of course not. But do I think there might be some bias in the VC industry where white male VCs in Silicon Valley will be slightly more likely to fund white male founders in Silicon Valley? Umm. Yes I do. That doesn’t seem very surprising to me?

Of course, VCs like money. And so they are at least financially incentivized to make unbiased decisions around which founders they invest in. But the whole point of bias is that it obscures economic rationality. And so again, if there is some inherent bias in how VC dollars are allocated in 2025 (which I would posit that there is), economic growth can be unlocked by trying to counter that bias.

This is one of our big ideas at Wefunder — that if we empower more women of color in Tennessee to become angel investors, then we can get more capital flowing to founders who look like them.

To the Investor Go the Spoils

These days, more and more companies are staying private longer. Compare Microsoft to SpaceX for a couple of extreme examples. Anyone can invest in public companies through the stock market. But early stage investing opportunities remain overwhelmingly limited to accredited investors. And the LPs in VC funds must be accredited.

There are very valid reasons for this. Early stage investing is much riskier than public investing. And much more illiquid. It’s critical to protect retail investors from bad actors, and even just from their own misunderstandings. This is, of course, why the Securities Act of 1933 prevented retail investors from investing in pre-IPO companies. But 2025 is not 1933, and the internet has done a lot to facilitate both the transparent sharing of information, and the self-education of “non-millionaires”. And the IRR of venture capital as an asset class out-performs the IRR of the public stock market. So if retail investors aren’t able to participate in private investment opportunities (venture capital) as an asset class, then this will be another force for the increasing concentration of wealth in the hands of the richest Americans. In 1990, the top 1% of the population held approximately 17% of the nation’s wealth. In 2022, that had increased to 26%. Of course, this isn’t all due to the fact that the wealth created by venture capital accrues to the richest Americans, but I would argue that it’s one driver.

Plus, speaking of drivers, I just think it would be cool if the next Uber IPO made a thousand drivers into millionaires.

No Silver Bullets

So to recap. Some problems with the VC-industrial complex as we enter 2025:

(1) Venture Capital is overwhelmingly focused on “power law” investing, which isn’t a good fit for the vast majority of companies started every year in America;

(2) There’s an inequity in which founders are getting funded by VCs today (in part driven by VCs wanting to invest in founders that look like them, and live near them);

(3) Middle class Americans currently don’t get to benefit (for the most part) from the wealth being created by VCs investing in private companies.

Many other problems too. The misalignment between founders and VCs, driven by the fact that VCs’ customers are their LPs; the fact that, according to this podcast, over 50% of founders are fired by their VCs; Vinod Khosla’s suggestion that 90% of VCs add no value to startups, and 70-80% add negative value; etc. etc. etc.

I’m actually personally a little more bullish on VCs myself than Mr. Khosla (himself one of the greatest ever). I think many VCs are great. And their money is especially great. It’s the color green, after all.

Of course there are problems with venture capital (as with any industry). Just as there are massive problems with community rounds (the democratization of early stage investing — what we do at Wefunder).

Wefunder is not anti VC. We actually think it’s awesome if startups raise capital from their customers and community, alongside VCs. Mercury is a great example ($120M Series B led by Coatue, and then they raised $5M from their customers through a community round). Or Beehiiv ($32M Series B led by NEA, and then $1M from their community in a couple of hours). Community rounds will never replace venture capital. Just as Airbnb (democracy) will never replace hotels. As Winston Churchill once famously quipped, “Democracy is the worst form of government. Apart from all the others”. But we believe that Wefunder can help tackle each of the problems with the VC-industrial complex identified above.

(1) Let’s say there’s a specific type of cancer that afflicts a small number of people. The TAM is not big enough to merit VCs investing. There’s no power law. But the families of people afflicted by that cancer might be willing to invest in its cure, even if the company only ever becomes worth $100 million.

(2) As mentioned above, if more people are empowered to angel invest in startups they love, we believe this can effect more equitable outcomes in terms of how capital is allocated.

(3) Revolut is a really powerful recent example of how hundreds of early stage customers were able to realize life-changing returns, alongside the company’s early venture capital and “accredited” investors.

Wefunder’s PBC charter doesn’t talk about ending or replacing capitalism, but fixing it. And it’s the same with venture capital. We don’t want to replace VC, but refine and improve it.