SoftBank’s big bang theory4 min read . Updated: 21 Oct 2016, 10:36 AM IST
SoftBank's $100 billion fund for technology start-ups will change the dynamics of start-up funding and may push other funds to follow suit
SoftBank Group Corp. recently announced a $100 billion global technology fund with the Saudi Arabian public investment fund. That is a lot of zeros for tech entrepreneurs.
On a more serious note, what does that mean for SoftBank? Why tie up yourself to a “tech only fund"?
The “tech only" question is not too hard to answer. SoftBank is not looking for 3x returns from investments worth a few million dollars, but multi-billion-dollar companies, which change the way we live. (Heard of Uber?)
While non-tech businesses also scale, nothing scales like technology. That gives tech businesses a very strong “winner takes all" flavour. For example, a social media platform (e.g., Instagram) can go from servicing 1 million to 100 million without even doubling the team size. Also, you can go from an Minimum Viable Product to a world changing company in just a few years.
Hence if you are looking to sniff out the next Airbnb or Twitter, tech is the best place to look.
The other characteristic of tech businesses is that at an early stage of their life cycle, the winners and losers look very similar. You only know who wins and who loses in retrospect. Look at the history of any successful tech start-up and you will see competitors, who looked just as strong at one point. Then something small changed the trajectory and wiped out the competition.
Hence, investing in tech start-ups is like buying an option. Your first round investment gets you a seat on the table. You can then closely observe potential winners and push them to the finish line. So you want to buy a lot of options to diversify the risk and catch the big winners.
One could argue that tech VC funds are dime a dozen. From the renowned ones like Kleiner Perkins Caufield & Byers and Accel Partners, to newbies that have recently learned to spell “technology". What advantage does a large tech fund give you?
We will argue that beyond a point, size can be a game changer. You don’t just do more deals but you get much better deal flow, and possibly terms, which competing funds do not. Here is why.
In tech, the ability to ramp up quickly is critical as success brings more success (like a snowball).
E.g., you will not go to an Airbnb competitor if it has fewer or poorer listings (the “network effect"). So the big become bigger, and wipe out the competition.
Hence, often funding itself can pick winners. Imagine five companies working on similar ideas and with similarly capable teams.
The one with most funding can spend more on marketing, hire better people, find more channel partners. That is where a SoftBank will have an edge over other VC funds since it can back companies right up to writing multi-billion-dollar checks.
Now if an entrepreneur has to choose SoftBank vs. a competing Silicon Valley fund, whom will she choose? What if SoftBank’s valuation is lower?
Entrepreneurs would rather go to SoftBank since it is unlikely that other funds will outspend you. Even more importantly, competing funds might hesitate to back competitors if they know that the winner has already been picked. So your prospects of future fundraising dim.
This will create the “SoftBank advantage".
Obviously these are generalizations and will not be universally true, but the logic is unmistakable.
There are many other advantages that such a huge pool of capital gives. Entrepreneurs across the globe will make SoftBank the first port of call.
Be it from Israel or India, you can find the best teams going to SoftBank.
And what does it mean for tech entrepreneurs?
There will hopefully be more support for potentially game-changing but apparently risky ideas. Investors are notorious for herd mentality (though everyone claims to be a contrarian). If “food delivery start-ups" are the flavour of the season, your start-up better have the word “delivery" somewhere prominently in the pitch.
Here, too, backing from a SoftBank-like player insulates you from such vagaries when you need the next round of funding.
Lastly, success for funds is skewed by a mega winner. For example, one could argue that Google made Kleiner Perkins while Facebook made Accel. So, if a large fund improves your odds to catch these mega winners at some stage of their funding lifecycle, then your prospects improve.
There are obviously dangers of so much money being in the hands of one team.
There is the classic problem of good money after bad money. Money makes people insular, arrogant, and sometimes data-agnostic. So, SoftBank has to build the right culture and risk management frameworks.
Overall, this columnist believes that this tech fund will change the dynamics of start-up funding and hopes there will be other funds following suit.
Let us look forward to more Googles and Ubers.
Shrija Agrawal is Mint’s deals editor. Due Diligence will run every week and cover issues in India’s venture capital, private equity and deals space.