Genesis: Summoning Venture 3.0

The Genesis is not a product spec. It is not an advertisement. It is an answer to why.

Early Stage Venture is Changing

We’re on the cusp of a new wave in the early stage venture capital ecosystem. In particular, the rapid decentralization of the core pillars that make up early stage VC is happening right in front of us:

Access to capital is becoming democratized. Technology and globalization as an equalizing force have a second order effect of rapidly increasing the count of high net-worth individuals (HNWI). The founder/successful retail investor demographic is no longer flocking to become LPs in highly competitive funds— it is nearly impossible to be an LP at a Tier-1 VC when you’re at competition with endowments, pension funds, etc. Instead, a more attractive option tends to be successful founders/investors running their own mini-funds (see Distributed Capital from the Halo team, Todd & Rahul’s angel fund, the Logos Fund, among many more). And with the SEC’s lowering the barrier on who qualifies as an accredited investor, it is clear that the micro-funds will become a norm.

Quality deal flow is a function of networks, and networks fundamentally belong to people, not brands. The fight to invest in the best new companies will be increasingly won by incredible people backed by incredible brands, not the opposite. At the onset, there was no A16Z without, well, “A” (Marc Andreessen) and “Z” (Ben Horowitz). Founders don’t work with firms, they work with individuals (often GPs/Associates) at the firm. While a firm’s brand building is important and relevant at later stages, the best deals come from personal connections, not from deals@vcfirm.com. Networks own deal flow, and people own networks.

Due diligence teams scale better when distributed. Larger firms with multiple funds can afford to hire research teams of PhDs to lead theses. This approach doesn’t scale to cash-tight, often illiquid micro-funds. Instead, using the age-old wisdom of the crowd mechanism, crowdsourced due diligence can achieve comparable insights to research teams, assuming the crowd has the right background to assess a deal. Crowdsourced knowledge is especially relevant as many venture firms are downsizing their staff in reaction to the mid-2022 bear market (1 and 2).

Primitives of distributed due diligence exists today: the Hacker News community is a technical community that quickly sniffs out the good tools from the bad ones. With the right tooling, the future of due diligence will be commoditized as part of the growing service DAO space that is taking on the $263B consulting market. This is the natural next step to the specialization of labor: from generalists who will miss obvious basics, to specialists on staff paid per diem, finally to specialist groups compensated on an adhoc basis.

Major signs point towards early stage venture decentralizing on different dimensions. But why?

Coordination failure.

Coordination failure: an existential threat to innovation

Coordination failure describes suboptimal outcomes to games that players fail to cooperate in. A harmless example: when people crowd around airport baggage claim conveyors: a small group of people acted selfishly by approaching the conveyor belt to grab their bag quicker, blocking the view of the belt to others. For fear of missing one’s own bag, everyone must then crowd the belt, resulting in more commotion and slower resolutions for everyone. While an extra few minutes to leave the airport isn’t a matter of life or death, coordination failure largely explains the failure to achieve nuclear disarmament in the 20th century. Instead of countries spending money of positive, nation-nurturing activities after an agreement to phase out nuclear weapons programs, trillions were spent in fear that one country could defect and dominate others.

Early stage venture suffers from micro-fractures of coordination failure.

Intra vs. Inter Coordination Failure

The Ethereum community has worked hard on solving intra-coordination failure. Forefront thinkers in the space like Ameen Soleimani have crafted the lore of “slaying Moloch, the rationalist god of coordination failure,” designing smart contracts that protect against coordination failure within orgs (intra-coordination). Codified principles like minority protection, pro-rata rights, and the power to freely exit have significantly dropped the cost of iterating on governance structures. We pay deep respect to the MetaCartel Ventures community that brought these governance structures to the venture capital space, building one of the first venture-investing communities governed by smart contracts.

As solutions arise for intra-coordination within venture organizations, a higher-order problem presents itself: inter-coordination failure. What does a landscape in which thousands of traditional firms, equity crowdfunding groups, angels, etc. exist in imperfect competition with each other? How do we account for conflicts of interest in which there are overlapping affiliations of individuals and their respect networks?

Inter-coordination failure between venture organizations is an existential threat to innovation. At the pre/seed stage, valuations for hot companies tend to get pumped up by two archetypes: late-stage funds paradoxically writing small checks with no regards to their allocation/startup valuation as they solely seek better access to Series A/B rounds, or early-stage funds offering sky-high valuations to get preferential lead positions. The former blocks founders from the critical mentorship/value-adds that the best early-stage venture capitalists provide. The latter, if executed many times over, results in firms getting lackluster ownership (and therefore lackluster ROI) in potentially stellar companies. These inflated valuations come to the detriment of projects when raising a Series A/B implies a down-round: either existing investors must prop-up the valuation by any means to salvage an initial investment, or founders struggle to raise as down-rounds are red flags to potential new investors.

The affect of coordination failures like this in the venture space is catastrophic. Disjointed, poorly incentive-aligned systems like the current venture capital space are inherently set to run sub-optimally, even fail.

Venture 3.0: the future of venture capital

Venture 1.0 was about the ‘Sand Hill Road,’ blockbuster institutional firm raising a mega funds to fund much of the development of internet. Because scaling technologies (namely, cloud infrastructure) were missing, many innovative companies poured cash into running and maintaining their own servers. This crutch, among the lack of other tools that made building ventures more costly, justified the need for big investments. Many of the rules of thumb of venture capital were written during this period.

Venture 2.0 was characterized by successful GPs and founders from Venture 1.0 making their own smaller funds and producing incredible returns (look no further than Chris Sacca’s Fund I for Lowercase Capital, which is one of the best performing funds at 213x thanks to his early investments in Twitter, Uber, and Instagram). Following suite in leaner funds were the likes of equity crowdfunding (WeFunder, Republic) and the rise of the angels (AngelList).

Venture 3.0 describes the future of venture capital— a unified protocol linking the full spectrum of investment vehicles, from angels to firms. We propose a collaborative, positive-sum game with ownership and composability at the center of the protocol.

Venture 3.0 Begins with Aligning Community Incentives

We look to venture DAOs (decentralized autonomous organizations) as a design paradigm that presents itself, in its current form, as ultra-lightweight, token native venture investing groups. They do not prescribe decentralizing any particular aspect of the venture lifecycle. In fact, venture DAOs as a design paradigm are that which can be encompassed by any investing community: angel collectives, venture firms, and investment DAOs alike.

Some characteristics that make these vehicles special:

• Low burn. Many traditional activities (deal flow management, accounting, due diligence) that would traditionally inflate overhead/staffing costs can be replicated with better coordination software (distributed due diligence, cap table management software, service DAO integration).
• Cheap to start. The right software enables near-zero coordination cost, and legal costs are being amortized by legal-tech companies like Doola.
• Community-centric. Well-designed tokens enable communities to engage in collective ownership and governance over both their funds and the organization’s direction.
• Scalable. Tokens can be designed to incentivize more people than just a “core” set of partners to engage in value-producing activities. Token incentives are a force multiplier for new and existing venture organizations to extend their reach far past those “on-staff.”

Venture DAOs are for everyone— from venture firms, to angel groups, to pseudonymous passion-groups. Composable infrastructure is key to the venture DAO paradigm adapting to a wide range of existing governance structures.

Note: Venture DAOs do not reinvent the wheel entirely. before venture DAOs were even a term, we’ve seen primitive nods to its inevitability: scout programs (Contrary, Open Scout, Draper, etc.), carry incentives, angel investment groups on AngelList, even equity crowdfunding sites like WeFunder have all taught the industry a lot about how early stage venture can be done differently. Venture DAOs are a design paradigm that enable us to take from these disparate spaces of learning, and craft new mechanisms better via composable tools.

Adopting the venture DAO paradigm also opens communities up to collaboration with the plethora of service DAOs that coordinate a distributed labor base for legal, accounting, design work, and more.

Scaling the Experiment

The Moloch and MetaCartel Ventures community served as incredible research points, proving that overcoming intra-coordination failure in venture is possible through codified governance.

Now, venture 3.0 must extend their work in two critical ways:

First, we must scaling intra-coordination success within venture DAOs, and extend venture DAO paradigm to existing entities in pursuit of community-first investing.

Second, we must develop solutions for inter-coordination issues to bring together hundreds of thousands of diverse entities in venture to interact in positive-sum games.

Collective Ownership is Necessary

Innovation is stuck in a loop. There is an ever-present ebb and flow— a bundling and unbundling— war between centralized parties and decentralized systems. New systems are made on open, decentralized protocols, corporations solve UX/aggregation problems and commoditize these protocols, community-wide anger with these rent-seeking parties disrupt the corporations with more open protocols, and the cycle repeats itself.

Collective prosperity is the only path forward. Much of institutional venture capital gets overturned by “disruptors” who then become the very institutions they sought to disrupt. Unnecessary competition like this (which damages the industry) comes from a lack of incentive alignment. The venture protocol of the future requires unification, not displacement, of all venture organizations via a well-designed token, one that enables all parties to share in the collective success of the new venture model.

Venture 3.0 does not displace the benefitted organizations in venture 1.0 and venture 2.0. It supercharges them, and enables the innovation-funding community at large to learn, iterate, and adapt together in ways we’ve never before seen possible.

Breathing New Life Into Venture

Nobody knows exactly what venture 3.0 will look like. In fact, venture 3.0 is characterized by scaling the ability to experiment with new mechanisms in venture.

We are at the dawn of a Cambrian explosion in venture. Better software, a favorable legal landscape, and an industry-wide urge for decentralization signals an unprecedented level of open experimentation that will breath new life into venture.

Seed Labs is powering the largest-scale experiment in early stage venture, with shared prosperity at the center of it.

You are a part of this story. Your contributions below— agreements and disagreements alike— will memorialize your beliefs in this turning point in venture.

The Genesis is not a product spec. It is not an advertisement.

It is a call for the venture world to experiment. A call to innovate. A call to imagine how we can do better.