The Case for Scaling Venture
Original author: Erik Torenberg, a16z

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In the traditional narrative of venture capital (VC), the "boutique" model is often celebrated, with the belief that scaling sacrifices soul. However, a16z partner Erik Torenberg presents a counterargument in this article: as software becomes the backbone of the U.S. economy and the AI era dawns, startups' needs for capital and services have undergone a qualitative transformation.

He believes the venture capital industry is undergoing a paradigm shift from being driven by judgment to being driven by the ability to win deals. Only "giant institutions" like a16z, with scalable platforms that provide comprehensive support to founders, can emerge victorious in trillions-of-dollars-level competition.

This is not just an evolution of a model, but a self-evolution of the VC industry in the tide of “software eating the world.”

In classical Greek literature, there is a meta-narrative above all others: respect for the gods versus disrespect for the gods. Icarus was burned by the sun not because he was too ambitious, but because he disrespected the divine order. A more recent example is professional wrestling: you can distinguish the face from the heel simply by asking, “Who respects wrestling, and who disrespects it?” All good stories take this form, in one way or another.

Venture capital (VC) has its own version of this story: “VC was, and always has been, a boutique business. Those large institutions have become too big and set their sights too high. Their downfall was inevitable because their approach was an insult to the game.”

I understand why people want this story to be true. But the reality is that the world has changed, and venture capital has changed with it.

There is more software, leverage, and opportunity today than ever before. There are more founders building larger companies than ever before. Companies are staying private longer than ever before. And founders have higher expectations of VCs than ever before. Today, the best founders need partners who are willing to roll up their sleeves and help them win—not just write checks and wait for results.

Therefore, the primary goal of venture capital firms today is to create the best possible interface to help founders win. Everything else—how to staff, how to deploy capital, the size of the fund to raise, how to assist with deals, and how to empower founders—derives from this.

Mike Maples once said: “Your fund size is your strategy.” Equally true is that your fund size is your belief in the future—it’s your bet on the scale that startups will achieve. Over the past decade, raising massive funds might have been seen as “arrogant,” but this belief is fundamentally correct. Therefore, when top institutions continue to raise large sums to deploy over the next decade, they are betting on the future and backing their convictions with real capital. Scaled Venture is not a corruption of the venture model—it’s the model finally maturing and adopting the very characteristics of the companies it supports.

Yes, venture capital firms are an asset class.

In a recent podcast, Sequoia’s legendary investor Roelof Botha presented three insights. First, despite the growing size of venture capital, the number of “winning” companies each year remains fixed. Second, the scaling of the venture capital industry means too much capital is chasing too few high-quality companies—therefore, venture capital cannot scale, and it is not an asset class. Third, the venture capital industry should shrink to align with the actual number of winning companies.

Roelof is one of the greatest investors of all time and also a wonderful person. But I disagree with his view here. (Of course, it’s worth noting that Sequoia Capital has also scaled: it is one of the largest VC firms in the world.)

His first point—that the number of winners is fixed—is easily falsified. Each year, about 15 companies used to reach $100 million in revenue; now, about 150 do. Not only are there more winners than before, but the winners are also much larger in scale. Although entry costs are higher, the output is vastly greater than before. The growth ceiling for startups has risen from $1 billion to $10 billion, and now to $1 trillion and beyond. In the 2000s and early 2010s, YouTube and Instagram were considered massive acquisitions at $1 billion: at that time, such valuations were so rare that we called companies valued at $1 billion or more “unicorns.” Now, we simply assume that OpenAI and SpaceX will become trillion-dollar companies, with several more to follow.

Software is no longer a marginal sector of the U.S. economy made up of odd, eccentric individuals. Software now is the U.S. economy. Our largest companies, our national champions, are no longer General Electric and ExxonMobil: they are Google, Amazon, and Nvidia. Private tech companies account for 22% of the S&P 500. Software has not finished consuming the world—in fact, accelerated by AI, it has only just begun—and it is more important today than it was fifteen, ten, or five years ago. Therefore, the scale a successful software company can achieve is greater than ever before.

The definition of a "software company" has also changed. Capital expenditures have surged dramatically—large AI labs are becoming infrastructure companies with their own data centers, power generation facilities, and chip supply chains. Just as every company became a software company, now every company is becoming an AI company, and perhaps also an infrastructure company. More and more companies are entering the world of atoms. Boundaries are blurring. Companies are aggressively verticalizing, and the market potential of these vertically integrated tech giants far exceeds that of any purely software company anyone imagined.

This leads to why the second point—that too much capital is chasing too few companies—is wrong. Output is vastly greater than before, competition in the software world is far more intense, and companies are going public much later than before. All of this means that great companies need to raise significantly more capital than in the past. Venture capital exists to invest in new markets. Time and again, we’ve learned that in the long run, the size of new markets is always much larger than we initially anticipate. The private market has matured enough to support top companies in reaching unprecedented scales—just look at the liquidity available to today’s leading private companies—and both private and public market investors now believe that venture capital’s output scale will be staggering. We have consistently underestimated how large the venture capital asset class can and should become, and venture capital is scaling up to catch up with this reality and the opportunity set. The new world needs flying cars, a global satellite grid, abundant energy, and intelligence so cheap it doesn’t need to be metered.

The reality is that many of today’s best companies are capital-intensive. OpenAI must spend billions of dollars on GPUs—more computing infrastructure than anyone imagined possible. Periodic Labs needs to build automated laboratories at an unprecedented scale to drive scientific innovation. Anduril needs to construct the future of defense. And all of these companies must recruit and retain the world’s best talent in the most competitive labor market in history. The new generation of major winners—OpenAI, Anthropic, xAI, Anduril, Waymo, and others—are all capital-intensive and have raised massive initial funding rounds at high valuations.

Modern tech companies typically require hundreds of millions of dollars in funding because the infrastructure needed to build cutting-edge technologies that change the world is extremely expensive. During the dot-com bubble, a "startup" entered a blank slate, anticipating the needs of consumers still waiting for dial-up connections. Today, startups enter an economy shaped by three decades of tech giants. Supporting "Little Tech" means you must be ready to arm David against a handful of Goliaths. Companies in 2021 were indeed overfunded, with much of the capital flowing into sales and marketing to sell products that weren’t even 10 times better. But today, funding is flowing into R&D or capital expenditures.

As a result, the winners are much larger than ever before and require significantly more capital from the outset. Therefore, it is only natural that the venture capital industry must become much larger to meet this demand. Given the scale of the opportunity set, this scaling is entirely justified. If VC fund sizes were too large relative to the opportunities available to investors, we would expect to see the largest institutions delivering poor returns. But we simply do not observe this. Even as they’ve scaled, top-tier venture firms have repeatedly achieved extremely high multiples—and LPs (limited partners) who gain access to these firms have as well. A renowned venture capitalist once said that a $1 billion fund could never deliver a 3x return because it was too large. Since then, certain firms have achieved over 10x returns on $1 billion funds. Some point to underperforming firms to criticize this asset class, but any industry following a power-law distribution will have massive winners and a long tail of losers. The ability to win deals without competing on price is what enables firms to sustain their returns. In other major asset classes, people sell products to or borrow from the highest bidder. But venture capital is a classic example of an asset class where competition occurs on dimensions beyond price. Venture capital is the only asset class with significant persistence among the top 10% of institutions.

The final point—that the venture capital industry should shrink—is also wrong. Or at least, it’s bad for the tech ecosystem, for the goal of creating more generational tech companies, and ultimately for the world. Some complain about the secondary effects of increased venture funding (and yes, there are some!), but it’s also accompanied by substantial growth in startup valuations. Advocating for a smaller venture ecosystem is likely advocating for smaller startup valuations—and potentially slower economic growth. This may explain why Garry Tan recently said on a podcast: “Venture capital can and should be 10 times bigger than it is today.” Certainly, if there were no competition, it might benefit an individual LP or GP to be “the only player.” But having more venture capital than today is clearly better for founders and for the world.

To further illustrate this point, let’s consider a thought experiment. First, do you think there should be many more founders in the world than there are today?

Second, if we suddenly had many more founders, what kind of institution would best serve them?

We don’t intend to spend much time on the first question, because if you’re reading this article, you likely already know that we believe the answer is clearly yes. We don’t need to tell you much about why founders are so exceptional and so important. Great founders build great companies. Great companies create new products that improve the world, organize and channel our collective energy and risk appetite toward productive goals, and generate disproportionate amounts of new business value and interesting job opportunities. And we are certainly nowhere near an equilibrium where every person capable of founding a great company has already done so. That’s why more venture capital helps unlock further growth in the startup ecosystem.

But the second question is more interesting. If we wake up tomorrow and the number of entrepreneurs is 10 or 100 times today’s (spoiler: this is happening), what should the entrepreneurial ecosystem look like? How should venture capital firms evolve in a more competitive world?

Play to win, not to lose everything.

Marc Andreessen likes to tell a story about a famous venture capitalist who said that the VC game is like being at a sushi conveyor belt: “A thousand startups go by, and you meet with them. Then occasionally, you reach out and pick one off the conveyor belt to invest in.”

The type of VC that Marc describes—well, for most of the past few decades, nearly every VC was like that. Back in the 1990s or 2000s, winning deals was that easy. Because of this, the only truly important skill for a great VC was judgment: the ability to distinguish good companies from bad ones.

Many VCs still operate this way—essentially the same way VCs operated in 1995. But beneath them, the world has changed dramatically.

Winning deals used to be easy—like picking up sushi from a conveyor belt. Now it’s extremely difficult. People sometimes compare VC to poker: knowing when to pick companies, knowing at what price to enter, and so on. But this may obscure the full-scale war you must wage just for the right to invest in the best companies. Old-school VCs miss the days when they were “the only players” and could dictate terms to founders. But now there are thousands of VC firms, and founders have easier access to term sheets than ever before. As a result, the best deals increasingly involve fierce competition.

The paradigm shift is that the ability to access trades is becoming as important as, if not more important than, picking the right companies. What good is picking the right trade if you can’t get in?

Several factors have contributed to this shift. First, the surge in venture capital firms has led to increased competition among VCs to secure deals. With more companies than ever competing for talent, customers, and market share, top founders need strong institutional partners to help them succeed. They need institutions with resources, networks, and infrastructure that can provide their portfolio companies with a competitive advantage.

Second, because companies remain private for longer, investors can invest later—when the company has received more validation, making competition for deals more intense—yet still achieve venture capital-style returns.

The last reason, and the least obvious one, is that selection has become slightly easier. The VC market has become more efficient. On one hand, there are more serial entrepreneurs continuously building iconic companies. If Musk, Sam Altman, Palmer Luckey, or another brilliant serial entrepreneur starts a company, VCs quickly line up to invest. On the other hand, companies reach massive scale faster (due to staying private longer and having greater upside potential), reducing the risk of product-market fit (PMF) compared to the past. Finally, with so many great institutions now active, founders find it much easier to connect with investors, making it hard to find deals that other firms aren’t already pursuing. Selection remains the core of the game—identifying the right enduring companies at the right price—but it is no longer the most critical factor by far.

Ben Horowitz assumes that consistently winning automatically makes you a top-tier firm: because if you can win, the best deals will come to you. Only when you can win any deal do you have the right to choose. You might not pick the right one, but at least you have the opportunity. Of course, if your firm consistently wins the best deals, you’ll attract the best pickers to work for you, because they want to join the best company. (As Martin Casado said when recruiting Matt Bornstein to a16z: “Come here to win deals, not lose them.”) Thus, the ability to win creates a virtuous cycle that enhances your picking power.

For these reasons, the rules of the game have changed. My partner David Haber describes in his article the shift that venture capital must make in response: «Firm > Fund».

In my definition, a Fund has only one objective function: “How can I generate the most carry with the fewest people in the shortest time?” Whereas an Institution, in my definition, has two objectives. One is delivering exceptional returns, but the second is equally interesting: “How can I build a compounding source of competitive advantage?”

The best institutions will be able to reinvest their management fees into strengthening their moats.

How can I help?

I entered venture capital ten years ago, and I quickly noticed that among all VC firms, Y Combinator was playing a different game. YC was able to secure favorable terms for outstanding companies at scale, while also seemingly serving them at scale. In comparison, many other VCs were playing a commoditized game. I would go to Demo Day and think: I’m at the poker table, and YC is the house. We were all happy to be there, but YC was the happiest of all.

I quickly realized that YC has a moat. It has positive network effects and several structural advantages. People used to say that venture capital firms couldn’t have a moat or unfair advantage—after all, you’re just providing capital. But YC clearly has one.

That’s why YC remains so powerful even after scaling up. Some critics dislike YC’s scale; they believe YC will eventually fail because they think it has lost its soul. For the past decade, people have been predicting YC’s demise. But it hasn’t happened. During that time, they replaced their entire partnership team—and still, death didn’t come. The moat is the moat. Like the companies they invest in, scaled venture capital firms have moats that go beyond just brand.

Then I realized I didn’t want to play the same homogeneous venture capital game, so I co-founded my own firm along with other strategic assets. These assets were highly valuable and generated strong deal flow, so I got a taste of playing a differentiated game. Around the same time, I began observing another firm building its own moat: a16z. So when the opportunity arose to join a16z a few years later, I knew I had to seize it.

If you believe in venture capital as an industry, you—almost by definition—believe in the power law. But if you truly believe that the venture capital game is governed by the power law, then you should believe that venture capital itself will follow the power law. The best founders will cluster around the firms that can most decisively help them win. The best returns will concentrate in these firms. Capital will follow.

For founders aiming to build the next iconic company, scaled venture capital firms offer an incredibly compelling proposition. They provide expertise and full-service support for everything a rapidly growing company needs—recruiting, go-to-market strategies (GTM), legal, financial, PR, and government relations. They offer sufficient capital to truly reach your destination, rather than forcing you to stretch every dollar and struggle against better-funded competitors. They deliver immense reach—connecting you with everyone you need to know across business and government, introducing you to every major Fortune 500 CEO and influential global leader. They provide access to 100x more talent, with a global network of tens of thousands of top engineers, executives, and operators ready to join your company when needed. And they’re everywhere—for the most ambitious founders, that means anywhere.

At the same time, for LPs, scaled venture capital firms are an incredibly compelling proposition on the most fundamental question: Are the companies driving the highest returns choosing them? The answer is simple—yes. All major companies partner with scaled platforms, often at the earliest stages. Scaled VCs have more swings at catching the important companies and more firepower to convince them to accept their investment. This is reflected in their returns.

Excerpt from Packy's work: https://www.a16z.news/p/the-power-brokers

Think about where we are today. Eight of the world’s ten largest companies are venture-backed firms headquartered on the West Coast. Over the past few years, these companies have accounted for the majority of global new enterprise value creation. Meanwhile, the world’s fastest-growing private companies are also primarily venture-backed firms headquartered on the West Coast: companies that were founded just a few years ago are rapidly approaching trillion-dollar valuations and the largest in history

IPO. The best companies are winning more than ever, and they all have institutional backing. Of course, not every institutional investor performs well—I can think of some epic failures—but almost every great tech company has had institutional backing behind it.

Go big or go refined

I don’t believe the future will be dominated solely by large-scale venture capital firms. Like every sector the internet has touched, venture capital will become a “barbell”: one end consisting of a few ultra-large players, and the other end made up of many small, specialized firms that operate within specific domains and networks, often in collaboration with scaled venture capital institutions.

What’s happening in venture capital is exactly what typically occurs when software consumes the services industry: on one end, four or five large, powerful players—often vertically integrated service providers—and on the other, a long tail of highly differentiated small suppliers that have emerged precisely because the industry has been “disrupted.” Both ends of the dumbbell thrive: their strategies are complementary and mutually empowering. We’ve also backed hundreds of boutique fund managers beyond institutions, and we will continue to support and collaborate closely with them.

Both scaling and boutique firms will thrive; it’s the mid-sized institutions that struggle: these funds are too large to afford missing out on mega-winners, yet too small to compete with larger firms that can offer founders better products through structural advantages. a16z’s uniqueness lies in occupying both ends of the dumbbell—it operates as a set of specialized boutique firms while also benefiting from a scaled platform team.

The institution that best collaborates with the founder will win. This could mean ultra-large-scale backup funding, unprecedented reach, or a massive complementary platform service. Or it could mean irreplicable expertise, exceptional advisory services, or simply incredible risk tolerance.

There’s an old joke in venture capital: VCs believe every product can be improved, every great technology can be scaled, and every industry can be disrupted—except their own.

In fact, many VCs fundamentally dislike the existence of scaled-up venture firms. They believe scaling sacrifices some of the soul. Some say Silicon Valley has become too commercialized and is no longer a haven for misfits. (Anyone claiming there aren’t enough misfits in tech clearly hasn’t been to a tech party in San Francisco or listened to the MOTS podcast.) Others resort to a self-serving narrative—that change is “disrespectful to the game”—while ignoring the fact that the game has always existed to serve founders. Of course, they would never express the same concerns about the companies they back, whose very existence is built on achieving massive scale and rewriting the rules of their respective industries.

Saying that scaled venture capital firms aren’t “real venture capital” is like saying NBA teams shooting more three-pointers aren’t playing “real basketball.” Maybe you don’t see it that way, but the old rules no longer dominate. The world has changed, and a new model has emerged. Ironically, the way the rules have changed here mirrors exactly how the startups VCs back disrupt their own industries. When technology disrupts an industry and a new wave of scaled players emerges, something is always lost in the process—but even more is gained. Venture capitalists intimately understand this trade-off—they’ve been supporting it all along. The same disruptive process VCs want to see in startups applies to venture capital itself. Software has eaten the world, and it certainly won’t stop at VC.

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