Full Stack Startups and the Resurgence of Venture Capital - 1

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Over the last couple of weeks a new meme courtesy of Andreessen Horowitz venture capitalist Chris Dixon has emerged: the full stack startup.

Some may view it is a new name for a slight variant on the idea of vertical integration, but there is a significant difference between the two concepts. Full stack startups (FSS) are a new breed of company that don't attempt to correct a particular problem within a larger process or industry. Instead, they reimagine and redesign a process altogether.

To be sure, there is an element of vertical integration within many of these ideas, as developing a new way to accomplish something can require building infrastructure and support services that don't yet exist. A simple example of a FSS is Tesla, rather than design and sell a battery to car makers, the company actually built a complete electric car. It owns the full product cycle, from designing to building and selling their product, rather than addressing one part of the process. Another example is AltSchool—rather than developing tools for teachers, it is building a new type of school altogether.

Taking a full stack approach to problem solving opens up new ways to address challenges, and therefore creates new opportunities for innovators. Starting this type of business can be fairly capital intensive and difficult to get going, but competitors will have significant barriers to entry if you are successful. While this is a somewhat novel and potentially useful approach to problem solving, that's not the primary reason I wanted to write about the FSS meme.

I think the meme is an indication that the venture market is shifting out of capital-efficient startup mode to a more aggressive position.

The timing makes sense when you consider all the recent exits companies have produced for investors. According to IPO researcher Renaissance Capital, "The US IPO market showed more activity than any other first quarter since 2000 as 64 companies raised $10.6 billion. That is more than double the number of IPOs in the first quarter of 2013, a year that also had the most public offerings in over a decade."

The market isn't showing signs of letting up, as this week alone 16 more US IPOs are planned.

That's to say nothing of the large acquisitions that have taken place, including Facebook's purchases of Whatsapp ($19 billion) and Oculus Rift ($2 billion), and Google's purchase of Nest Labs ($3.2 billion). According to investment bank The Jordan, Edmiston Group, "the media, information, marketing and technology sectors saw 374 transactions announced in the first quarter of 2014, at a total value of $41 billion." All told, more than 430 companies produced over $50 billion of liquidity for investors in Q1 alone.

I hate to generalize, but during my time as a VC fund-of-funds manager, I noticed that, historically, when fund managers make a bunch of money, they find ways to put more money to work. This means raising larger funds, or going downstream to participate in later stage financings (like Lyft and Uber's recent matching $250 million capital raises or Airbnb's expected $400+ million round that would value the company at $10 billion.)

It also means that firms might write larger checks to entrepreneurs who can sell big visions—you know, like full stack startups that plan to reimagine traditional industries.

This is great news for founders. If you have a revolutionary idea about how to change an outdated industry, you might find an investor who will buy in early. There's no denying that there are new opportunities in various markets because of technological innovations in sensors, telecom infrastructure expansion, 3D printing, drones, nanotech, artificial intelligence, clean energy, Bitcoin, and more. Not to mention, an emerging class of peer-to-peer and crowdfunding opportunities enabled by the critical mass of buyers and sellers now online.

Unlike a number of mainstream media pundits, I don't view what we're seeing as a bubble forming, in part because many of the companies going public are capitalizing on these macro trends or have strong underlying financial performance. Also, it's hard to believe that we could be entering a bubble when so many public figures are already shouting "Bubble!"

The last bubble is still fresh in people's minds, and I suspect that people who invest in recently IPO'd companies understand that they're taking on higher than average risk in exchange for potentially above average returns.

Whether or not you support an increased volume of high-risk/high-reward capital in public equities, I believe that it's beneficial in private equity. It encourages and enables people to start truly innovative businesses with the potential to have huge social and financial impact.

There is a lingering (albeit restrained) criticism of VCs for funding trivial companies that are evolutionary rather than revolutionary. Even if you believe that this view is justified, a sizeable chunk of the blame should be laid at the foot of the capital-efficient growth model employed by many of today's businesses.

Building something revolutionary requires significant development time, which requires money to pay product teams to construct a reasonable minimum viable product. Can you imagine a Tesla or AltSchool MVP being built through the currently popular capital efficient model? They never would have gotten off the ground. When you have limited resources, you resort to solving parts of processes—essentially iterating on existing models. When you have significant resources, you are not restricted.

It's natural for venture capital to go through expansion and contraction phases, and I believe both parts of the cycle have benefits and drawbacks. The asset class has been down for several years, prompting respected groups like the Kauffman Foundation to proclaim less than two years ago that venture capital is broken.

As an entrepreneur, I'm heartened to see investors like Dixon courageously tout full stack startups. And I'm happy to see the asset class start to produce excellent returns once again, bubble theorists be damned.