Going from a proof of concept fund to an “institutional” venture fund

Going from a proof of concept fund to an “institutional” venture fund

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture and start-ups. Over the past several years, we’ve spent considerable time studying and writing about the rapidly evolving emerging manager venture landscape. As illustrated by the chart below (data courtesy of Pitchbook , combined with our own data tracking), the propagation of new firms has intensified in the last two years and since the beginning of 2017, more than 50% of total funds raised have been fund 1 offerings. With the barriers of entry being low for the smallest venture funds, many new entrants are managers that bring minimal prior professional investing experience. As such, a significant portion of new offerings are in the sub-$25MM range and are primarily backed by high net worth individuals and smaller single family offices. When examining this segment more closely, over 50% of first time funds (post 2016) in the sub-$25MM segment raised funds that were under $15MM at final close (funds in this size range are often referred to as proof of concept or nano-funds). With the economic and operational challenges these size funds inherently present to GPs (notably fee stream and reserve capital), the business plan for managers starting these funds is fairly typical — execute a given thesis effectively and transition from a proof of concept fund to larger subsequent funds that are backed primarily by institutional LPs. This path to institutionalization was one that many first and second generation (pre-2014) Micro VCs successfully navigated. In this past, this leap was perhaps a bit easier to make given fewer managers in market, active emerging manager mandates by LPs, and greater emphasis placed on portfolio mark-ups. Attracting institutional LP capital is almost always a necessary component for scale and durability (please note in the context of this post that I’m referring to institutional capital as allocations that are at least 5–10% of a fund, and not pilot checks that some institutional LPs deploy for relationship building or optionality). Before we get into the current market and the considerations going forward to become institutional, we believe there are three broad emerging manager segments: Late seed/Series A ($75MM+) – Post-seed/Series A round lead investor – 2–3 partners – LP base that is largely institutional (70%+) – Scaling in fund size often planned for subsequent funds Institutional Seed ($25MM-$75MM) – Lead rounds across seed spectrum (pre-seed — post-seed) – 1–3 partners – LP base mix of institutional investors and non-institutional (With the former being a larger component for funds at the top end of this range) Co-invest seed ($0–25MM) – Typically act as co-investor (versus lead) in majority of deals – “Proof of concept” funds (particular with funds <$15MM) – LP base primarily High Net Worth...

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Tips to write a great venture fund pitch deck

We recently published an updated list of US based Micro-VCs and as of today, we count over 600 active firms. Unsurprisingly, for those fundraising, standing out from the pack is an increasingly difficult endeavor. As most Micro-VC’s don’t have the luxury of long and prolific investing track records, managers must convince prospective investors to invest only using limited data points and projections to support a given thesis. One of the key documents in any fundraising is a pitch deck. A well-constructed pitch deck can create an instant visceral engagement with the reader through clear deliverance of a narrative. Having reviewed 350+ venture fund pitch decks over the past few years, very few effectively convey the message the manager intends. Of course, a great deck isn’t a direct guaranteed pathway to an allocation, but it sure does improve the probability of one. It also presents a manager with an opportunity to fine tune/stress a pitch and potentially initiate positive momentum going into an investor call. While decks are bespoke by design, there are some basic tips we think may be helpful to consider when putting together a fundraising venture fund pitch deck. Content An effective pitch deck clearly articulates why the manager has an opportunity to be a consistent outlier performer (for seed funds, outlier performance typically refers to 3X or above cash on cash return). As such, the deck should tangibly address the following: a. Why the firm will have access to the most interesting companies and entrepreneurs within the thesis. b. Why the firm will win the most competitive opportunities. c. What makes the team uniquely positioned to execute the outlined thesis. In addressing the items above, it’s imperative that the content be inclined toward the specific formula the firm employs for each versus basic anecdotes or generalizations. Understand that LPs are carefully evaluating how the puzzle pieces specifically fit when determining the strength of model versus others. -Resist the urge to include proclamations or promises of fund performance (i.e. “5x target returns). Such statements carry little weight for LPs, and often infer manager naïveté. -In certain cases, a competitive positioning slide may serve helpful in framing for investors where you “fit in” within the seed stage landscape while concurrently demonstrating keen comprehension of the competitive landscape. -Slides with a large list of advisors rarely hit the bulls-eye, particularly for sophisticated LPs — Name brand advisor slides feel like vanity slides while a long list of non-name brand advisors doesn’t carry much impact. If you must include advisors, simply include a smaller group of network relationships that are truly meaningful to the story. A well thought out advisor slide illustrates why certain advisors are critical to the firm by conveying...

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What it means to be differentiated as an Emerging VC

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of early stage venture and start-ups. It’s clear through the first half of 2018 that the pace of new Micro-VC firm formations hasn’t slowed (and in fact appears slightly ahead of 2017’s record pace). Understandably, sophisticated LPs that allocate to emerging managers are laser focused on finding managers that can demonstrate meaningful differentiation prior to committing. Most new venture managers appreciate that some competitive edge is needed, but often miss on what it means to be meaningfully differentiated. Since selling LPs solely on the premise of being a better picker of companies is next to impossible, it’s best for managers to focus on strategies that demonstrate clear advantages when it comes to sourcing, winning, and post-investment activity. As an aside, I think it takes ~10 years of consistent performance before a case can be made that someone is a good picker and advisor of companies (luck and limited sample sizes make measurement of skill impossible in the early years). With that backdrop, let’s examine the key components necessary for a meaningfully differentiated model. All of these should be present within a firm that exhibits true differentiation. It’s tangible and durable Fledging firms should have some type of “moat” that gives them some degree of an advantage versus peers that play within a similar investment thesis. This moat should be very difficult for others to replicate, and be very clear for founders to understand. This moat could be simple as superior domain expertise or network, but needs to be extremely specific in nature (i.e. “rolling up my sleeves and hustling” or having an “awesome network” with no specificity are not examples of moats). Additionally, any moat should reasonably stand the test of time. As a result, a core primary differentiator for a firm can’t be simply be running a geographically or stage focused firm. In these cases, market forces tend to ultimately converge and create atrophy in any advantages that might have been initially present. It’s systematized When I review strategies with managers, I generally look for an “operating methodology” that demonstrates some sort of definitive framework on how the firm invests, picks, and adds value to portfolio companies. Having this type of framework allows for a few things: 1/ It allows for consistency of approach, a key driver of repeatable performance across funds. 2/ Creating a framework enables performance measurement around processes, which is particularly important as the feedback loop for relevant investment performance is incredibly and painfully protracted. 3/ It provides clarity and transparency for founders and LP’s into your culture, value add, and method of conducting business. Creating something systematized doesn’t need to be overly complex, but needs to be something that...

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LP survey results: What LP’s are saying about emerging venture manager funds

LP survey results: What LP’s are saying about emerging venture manager funds

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of early stage venture and start-ups. This post serves a part one of a two part series that Beezer Clarkson at Sapphire Ventures and I are co-authoring to help VC’s (specifically emerging managers) navigate through fundraising cycles and engender better and more relevant relationships with LP’s. During the 3rd annual emerging manager focused RAISE conference, I presented the results of an LP survey that was conducted with RAISE LP conference attendees prior to the event.  The primary goal of the survey was to better understand the current temperament of LP’s as it related to venture allocations in emerging managers.   The sample size of the survey was approximately 60, and represented a good cross section of LP profiles with fund of funds, foundations, endowments, family offices, and wealth managers all participating. Without question, there are many components to a successful fundraise.  An important factor in mitigating fundraising friction is a keen sense of the profiles of LP’s, their typical preferences, and sensitivities, and then using this knowledge to build a fundraising strategy centered on LP/GP fit. We’ll discuss how to assess LP/GP fit in part two of this series, but in this post, we’ll review the findings of the LP survey in detail.  I’m linking the entire presentation here for reference. Survey Findings For new venture managers (many Fund I/II profiles), family offices and high net worth individuals are unequivocally going to comprise the majority of the limited partner base and time should be accordingly spent to this finding. For all of nearly 150 venture funds on Fund I and II that we’ve tracked since the beginning of 2017, nearly 50% represent funds that currently have <$20MM closed.  As the chart below shows that >60% of institutional allocations are $5MM+ and recognizing that LP’s rarely want to constitute more than 20% of the fund, institutional LP’s often represent poor fits for those that are raising funds of $25MM and lower.  This further highlights the importance of thinking realistically when setting fund targets as to avoid too many unnecessary conversations with those LP’s that aren’t immediate fits.   Although no LP type indicated that they expected to allocate extremely actively to emerging managers (Fund I/II) during the next 18 months, Fund of Funds appear to be the most active allocators on average. It’s important to note that there are any more single family offices than fund of funds and we  expect that if examined universally, that the majority of emerging fund allocations by volume will likely come from family offices.  In an informal survey we conducted with emerging GP’s earlier in the year, fewer than 35%...

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Realistic fundraising targets for emerging managers

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of early stage venture and start-ups. The recent article I posted about the current fundraising environment focused primarily on the macro conditions driving limited partner appetite into emerging fund managers, which of course, are nearly impossible to control or predict with any effectiveness. While market conditions are uncontrollable, it’s critical that managers thoughtfully construct strategies that optimize the probability of a successful raise . Drawing from my experience having worked with over 300 emerging fund managers during their fundraising efforts over the last 6 years, I’ll be focusing my next few posts on some of the important elements of ensuring a successful raise. One of the difficult exercises for fund managers is getting the right fundraising target right, as setting a target too high or too low comes with risks: Too high: · Generally necessary for the fund to hold a significant first close to show viability of model to both first close and later close investors. · Risk of an offering getting stale if the market doesn’t respond favorably and relatively quickly. Reducing a target mid-way through fundraise is as painful as it sounds. · Loss of credibility if target is not congruent with market realities. · High opportunity cost (doing deals) of a protracted fundraising cycle. Too low: · Can eliminate certain classes of limited partners (institutional) · Fund size doesn’t allow for the optimal fund construction to execute a given strategy · Fees from a small fund may not provide sufficient fees to execute on thesis, or incentivize manager enough. · LP’s may equate those with overly modest targets as “venture capitalists in training” Setting the right target is a delicate balance between market realities and a lucid understanding of one’s business model and what is needed to create an optimal economic framework for all constituents of a firm. For example, it doesn’t make much sense for a post-seed focused manager to raise only a$10MM. Similarly, a sole GP manager with a limited track record is unlikely to be successfully if he/she sets a target of $100MM. *Quick aside note for managers: avoid the urge to adopt the business model of prospective limited partners as your own. Just because an endowment or pension suggests that you should be $100MM (because they need to write a $10MM-$20MM check to be worthwhile), it doesn’t mean it’s the right (or realistic) target. I see far too many managers still follow into this trap. Rather, it’s best to brutally take inventory of your current profile and needs, and stress test it against market conditions. As I don’t know the specific profile of every fund manager reading this, I’ll instead...

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Why a fundraising winter is coming for Micro-VC’s

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of early stage venture and start-ups. Recently, I received an email from a seed fund manager inquiring about current Limited Partner appetite for investing in new seed fund managers. The query was in response to a declaration made by someone closely connected to LP’s that the current fundraising environment for venture is worse than what we saw following the housing bubble collapse of 2008. I’m not sure I fully agree with the statement when juxtaposing 2009 with today’s macro environment. Even with the recent public equities sell-off, the Dow is 3.5X larger than during Q1 2009. The current unemployment rate of 4% is less than half of what it was in 2009, and economic fundamentals appear to be robust. And with four consecutive years of $30B raised by US venture funds, it appears to be a very strong fundraising market for venture. However, putting aside these macro fundamentals, I do believe that the statement has merit within the emerging manager circuit, and for many new firms (particularly unproven Micro-VC’s) raising in 2018, the chill may be similar to what all of venture faced in 2009 and 2010. So why do I think that this will be the case? Many Limited Partners made their Emerging Manager bets during 2013–2016. As shown by the chart below from May 2017, 480 sub-$100MM fund I offerings were raised between January 2013 and December 2016.  During this time, both family offices and institutional investors (Fund of Funds, Endowments, and Foundations) actively invested in new emerging manager funds in hopes of landing an early spot with the next First Round Capital, True Ventures, or Felicis Ventures — note that many LP’s have had active emerging manager mandates over the past 5 years. However, beginning in early 2017, I’ve observed large masses of institutional LP’s recasting strategy and becoming content with simply following on to the bets they made in 13’-16’, and only opportunistically adding new names (often only 1–2 names/year). With many existing Micro-VC firms coming back to market in 2018, a significant portion of institutional allocation is already be spoken for. Higher opportunity cost For most new managers without existing and transferable investing track records, the family office market has served as the primary source of capital.Aside from the difficulty of finding family offices that are allocating into venture funds (most do not publish investing strategies publicly), the bar for meaningful allocations ($2MM+) has dramatically moved upward in recent quarters. Much of this reality centers on rising opportunity costs, both with other venture investment opportunities and other asset classes. On the former, Preqin pegged nearly 600 1st time funds in market globally in their recent report. This level of competition ensures that securing...

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Deconstructing the seed round implosion

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of early stage venture and start-ups. The recent TechCrunch article illustrated a stark downward movement in the total number of venture deals completed over the past few years, something that those intimately close to the venture market have experienced first-hand. The data supporting this shift may surprise some when seeing that annual deployed capital has increased over the same period. There are many fairly obvious reasons for this, including venture investors concentrating capital into “winners”, protracting exit cycles forcing funds to reserve more capital for follow-ons, and larger fund sizes leading to traditional VC’s investing later in company life cycles. As the chart below illustrates, the data is especially harsh on the seed stage funding market, with number of seed deals done per quarter dropping nearly 50% from the highs in 2015. On the surface, this feels even more counterintuitive than the broader venture deal trend when looking at the growth in new seed fund focused venture fund managers since 2015. The chart below illustrates this growth (Note this is as of 5/11. We’ll be publishing the year-end numbers in January, and I expect the number of seed funds closed to be greater than 2016 figures). So what’s really happening within seed? 1) Relative to traditional venture, the seed fund market exhibits stronger collegial tendencies, and it’s not atypical to have seed rounds with multiple seed fund participants. According to PitchBook data, the average number of seed funds in a seed round in 2017 was 4.8, meaning an average seed round completed in 2017 had nearly 5 seed funds participating! This speaks directly to the growth in size of seed rounds, but also to the reality that the majority of seed funds won’t or can’t lead seed rounds. 2) The data for seed rounds has always been a bit opaque, especially with very small rounds, many of which are not disclosed. As such, I think the absolute number of seed rounds completed this year is likely quite depressed from deals actually done (however it doesn’t negate the downward as opacity has always been an issue). 3) It’s important to note that PitchBook’s seed round definition is limited to companies that are <2 years in age that raise a pre-Series A round. As seed fund investors have continued to pile into late seed/post-seed, it’s not atypical for companies to be forced to wait 2 years or more for a substantial seed round, and alternative sources of capital in the meantime (crowdfunding/bootstrapping/accelerator funding), many of which aren’t disclosed. Additionally, many companies raise multiple seed rounds prior to a traditional Series A round, some of which come after 2 years in existence. 4) Gray...

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Why Fortune favors the bold in Venture

Why Fortune favors the bold in Venture

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of early stage venture and start-ups. With the number of seed funds rising daily, I often get asked the following two questions: 1) Is there too much institutional seed capital? 2) Are there too many seed funds? While often conflated, these are two very different questions. Is there too much seed capital in venture? No, I don’t think there is too much institutional seed capital. I’d posit that the ~$4B raised annually by seed VC’s (along with the nominal seed allocations for traditional venture funds) is relatively light when compared to the opportunity within the innovation sector. Not unlike the industrial revolution of the late 17th century, I believe we are just entering into a similar revolution borne out of the technology sector. While technology booms in the past were typically a function of specific innovations (internet, mobile, mainframe computing), we currently live in a world of technological ubiquity that is enabled by robust infrastructure and distribution networks and more importantly, pervasive consumer/commercial acceptance and adoption of technology. Look no further than the public markets where the top five US public companies by market value are technology companies, valued collectively at $3T. Traditional non-technology companies have also tangibly acknowledged that adoption of technology is no longer an option, but a necessary component of survival and scale. This has spurred a massive increase of corporate venture capital in recent years along with substantial growth of acquisition of technology companies by non-traditional acquirers such as Wal-Mart, Unilever, and General Motors. Are there too many seed funds? While the answer is much more nuanced than just the visceral “feel” of too many funds, the answer is probably still a yes. Before I delve into the why, let’s acknowledge the benefits of having 500+ seed funds, including mass optionality for founders and the positive impact the seed fund universe has had in driving diversity at the investing level. That said, a venture fund’s viability is a function of its ability to drive consistent returns for its limited partners, and the growth in the number of seed funds has required managers to navigate much more complex waters to generate alpha returns. Despite the advantaged mathematics of returning a small fund, the reality is managers already faced long odds of returning alpha (3–5X) before the saturation of the seed fund market. The charts below illustrate the home run driven nature of venture capital, regardless of fund size (courtesy of Horsley Bridge). While some may opine that massive home runs are necessary just for larger funds, the math suggests otherwise. I acknowledge that the he necessity of outlier outcomes for alpha venture fund performance isn’t by any means a profound insight....

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“Raising a venture fund versus starting a venture franchise?”

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture and start-ups. It’s an immutable fact that delivering strong returns are necessary in building an enduring venture franchise. In my last post, I discussed the three important components of investing (sourcing, picking, and winning) and how managers should assess their differentiation around those items. Most new venture managers consider these elements of investment strategy before launching, but other key basics of running a venture franchise don’t often receive enough consideration at the front-end. Just like any company, a venture firm has multiple constituents to manage: shareholders (LP’s), clients (portfolio companies), and partners (co-investors, service providers, etc.). When talking with aspiring venture managers, I often hear “I want to raise a fund” rather than “I want to build a great venture franchise”. Although perhaps I’m being overly nuanced, the latter statement creates a more appropriate mental framework when contemplating getting into venture. While fundraising and investing are key components of a new fund, addressing the firm’s core mission, values and infrastructure are crucial to building a durable franchise that will grow beyond the first check. Mission Nearly every successful company has a clear mission statements that describes succinctly the reason for “why do I exist”. A venture firm’s mission statement should be clear to all constituents of the firm (firm employees, LP’s, and founders) to ensure focus, discipline, and unity of organizational direction. First Round Capital, YC, and Andreesen Horowitz all have done great jobs about identifying their respective missions. A mission statement shouldn’t be complex, but should be authentic and be able to serve as the directional compass for the firm. Team Construction While good team construction doesn’t appear like something that needs to be reinforced, history suggests otherwise given the poor succession planning, lack of diversity, and partnership conflicts that litter the industry. One recurring mistake I see managers make is building a team as byproduct of what they believe will accelerate fundraising. From experience, patchwork or “latch on” partnerships seldom work, and likely will lead to conflict (or worse) at some point — I can’t begin to count how many conversations I’ve had with GP’s who are dealing with unhealthy partnership dynamics. Additionally, once a partnership has been identified, all key issues and potential scenarios must be discussed at the outset, no matter how uncomfortable the conversation. Not having these frank conversations upfront will almost assuredly create really uncomfortable dialogues later. Core Values While firms often speak about core values, very few truly build an organizational ethos around them. When speaking about core values with venture managers, we usually find that none have clearly been set, or if they have, little time has been spent...

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Things to think about before launching a venture fund

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture and start-ups Along with the reasons I’ve previously discussed, this list and chart below clearly suggest that becoming a venture investor (or more specifically a seed stage VC) is easier than it’s ever been. Yes, fundraising is hard, but with patience and pragmatism, the barriers of entry are low for new entrants. 500+ seed funds! While entering VC is one thing, having staying power is another, and the challenge of building and maintaining a durable venture franchise continues to increase. It’s why I often ask aspiring venture managers the blunt question — “Why do you exist”? I ask this question because I want to understand why they are starting a firm, and more importantly, why they believe their firm will stand the test of time in such a crowded field. It’s an inquiry that is often met with generic marketing speak and misplaced moxie, but it’s a question that all prospective venture managers should brutal confront prior to taking third party capital. Starting a venture firm isn’t just about raising a fund and investing in new companies — it’s a commitment to your constituents (LP’s, entrepreneurs, employees) to be a great long term steward of the business. Outside of a few exceptions, I’d strongly discourage managers that are not 100% ready to commit the next 20 years of their careers to building their proposed franchise from raising a fund until they are sure. For managers that are committed to building a venture firm capable of consistent alpha returns, what is needed? Many LP’s would answer that it comes down to the manager being substantially “differentiated” from their peer group. The reality is that almost all successful fund managers possess a degree ofauthentic differentiation, a trait or set of traits that clearly points to a meaningful and comparative advantage relative to the competition. Because venture is an asset class with skewed returns requiring both skill and luck, authentic differentiation is the fundamental basis that increases a firm’s probability of producing consistent outsized returns. Authentic differentiation can be measured in many ways, but I want to focus the scope of this article on how it translates to the three core building blocks of venture investing: 1. Sourcing 2. Picking 3. Winning Sourcing Nearly every manager I meet expresses that they have great deal flow as it relates to companies that fall within their investment thesis. Many managers overrate their deal flow by anecdotally recalling quality deals or viewing deal flow strength through the lens of deal velocity. Possessing a competitive sourcing advantage relative to others requires consistent access to highly curated pools of top founder talent. From my experience, firms with authentic sourcing advantages are intensely formulaic in building...

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