This column originally appeared in the December 2015 issue of Venture Capital Journal

By John Backus

“Creative Destruction,” a term coined by economist Joseph Schumpeter almost 75 years ago, is the fundamental foundation of venture capital, driving financial returns to LPs, wealth creation to entrepreneurs who re-invent industries, and job creation in the global economy.

So what will be the force of Creative Destruction in the industry of venture capital?

A prediction:  2016 is the year that the pro-rata rights ecosystem begins to institutionalize and shakes up our industry.


Since the tech bubble burst in March of 2000, we have seen a wave of disruption and innovation in our industry.  The secondaries market exploded following the 2000 and 2008 financial crises.  The passage of the 2012 JOBS act (which NVCA played a vital role in) brought us crowdfunding.  Second Market, acquired by NASDAQ in October this year, promises a real non-public securities marketplace.  AngelList created the first at scale investing platform for our ecosystem – and now intends to monetize it as a principal investor.  In a similar vein, Y Combinator proposes follow-on investment in its funded graduates with its new $700M Continuity Fund.


History will show that Opportunity Funds were first to fundamentally alter the equation in the venture capital industry. Harvard Business School’s William Sahlman states that “80% of a VC Fund’s returns are generated by 20% of its investments” and opportunity funds capitalize on this notion. Every venture firm wants to invest in the handful of companies that generates the highest return.  They compete vigorously for the chance to invest in these companies.  Some compete on the basis of their brand.  Some offer to pay the highest price.  Others suggest they can bring strategic value, or that they have unique insight using a data-driven approach.  Yet those who pioneered opportunity funds recognize that, while everyone competes to invest in the best companies, there is a better way to get access to these very best companies – and that is to already be an existing investor.  And to use one’s existing pro rata right – the absolute right to further invest in the company – to maintain ownership and upside.


At our firm, when we are evaluating a new investment, we always ask, “Why this?  Why now?”  In other words, if this is such a good idea, why hasn’t it been done before.  Four intersecting trends suggest that the pro rata economy is here to stay and will become a force:

  1. NVCA data shows that IPOs are taking twice as long to reach the public markets as they used to. Today, on average, a company will enter the public market at year 8. 20 years ago, it took just 4 years.
  2. Along the way, the best companies are raising a lot more money before they exit.  $48 Billion in venture capital was deployed last year, the most since the year 2000, according to the MoneyTree™ Report by PricewaterhouseCoopers LLP (PwC) and the National Venture Capital Association (NVCA), based on data from Thomson Reuters.
  3. Raising more money and going public later means that the earliest investors own a much lower percentage of the company at exit than they ever did.
  4. Finally, exits today are much more valuable – the mean enterprise value at IPO is 5X higher today than it was 20 years ago, while the average IPO is 10X higher, suggesting a big increase in extremely valuable companies.

As a result, the pro rata right to invest in future rounds of great companies, held by all investors, but disproportionately by the earliest investors, has become a very valuable asset.  Yet in 2014, 8 VC funds raised $12B while 246 funds raised $18B, which means capital is concentrated in a handful of large funds.  But the majority of investments in venture-backed companies are made by the big number of smaller funds.  These smaller funds are the ones waking up to the value of their pro rata rights in later rounds in their best companies.


Much like the new Star Wars movie – the Force Awakens – promises to be both memorable and lucrative in epic proportions, the pro rata rights economy is the force that will change the landscape of the venture industry forever. Investing in funds that help smaller VCs monetize their pro rata rights will change the math equation. 2016 will be the year when Limited Partners will decide to participate in this new economy.

John Backus is a venture capital investor at NAV. He serves on the board of the National Venture Capital Association (NVCA) and is a member of its executive committee. He can be reached by email at or you can follow him on twitter @jcbackus.