What was true in the venture capital dynamic yesterday, isn’t anymore. The VC ecosystem has long operated on a predictable model, but a fascinating irony lies at its core, reshaping how startups build and scale in today's capital-efficient environment.
The Symbiotic Irony
Small funds often need mega funds. The traditional venture conveyor belt sees breakout companies relying on deep-pocketed follow-on capital to scale.
But mega funds always need small funds. Without early-stage backers taking the initial leap, there's no pipeline of breakouts to write those big checks into.
This asymmetric dependency creates an interesting power dynamic that's increasingly tilting in favor of smaller, nimbler funds.
Why Operator Fund 1s Outperform
The data shows that first-time funds led by operators consistently outperform their peers. Consider these statistics:
- First-time funds in the top quartile deliver 3.3x returns versus 2.5x for established funds
- Operator-led Fund 1s have a 25% higher probability of delivering above-market returns
- 62% of unicorn companies had at least one operator-led fund in their early rounds
Former operators bring unique advantages to early-stage investing:
- Fresh networks of founders still actively building
- Recent operational expertise relevant to today's challenges
- Greater hunger and focus with smaller portfolios
- More aligned incentives with founders
The Rise of "Seed Strapping"
Founders are starting to question the conveyor belt altogether. The rise of "Seed Strapping" — raising enough to build, ship, and drive profitability early — is becoming more common. Today, you can build something huge with a lean team and very little capital.
Take DoNotPay: raised a Series B four years ago, now significantly profitable and paying dividends to investors. Its last valuation was $210M. Will it return a large fund? Probably not. But for its early backers? It just might deliver exceptional returns.
The New Capital Efficiency Reality
Modern startups benefit from transformative changes that favour capital efficiency:
- Cloud infrastructure costs dropped 80% over the past decade
- Distribution channels have democratised access to global audiences
- Remote work expanded talent pools while reducing overhead
- No-code/low-code tools dramatically accelerated development cycles
These factors create perfect conditions for small funds to thrive independently.
The Future of Venture Funding
Back to the irony — small funds may sometimes need mega funds. But maybe less than before. Mega funds? They'll always need small ones to get the party started.
As this power dynamic continues to evolve, we'll likely see smaller funds commanding more favourable terms and greater influence in the venture ecosystem. The most successful mega funds will be those that build genuine partnerships with operator-led Fund 1s rather than viewing them merely as sourcing channels.
The conveyor belt isn't broken, but it's certainly being reimagined.
Noa Khamallah is General Partner at Don't Quit Ventures.
