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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What you need to know before raising a Micro-VC fund today

What you need to know before raising a Micro-VC fund today

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture and start-ups. Although I’ve never raised a venture fund myself, I can claim having worked closely with managers on nearly 200 fund raises over the past 5+ years. These raises, coinciding with the incredible growth of new venture firms over the past 6 years, primarily relate to those in the Micro-VC sector (firms focused primarily on seed stage investing with fund sizes <$100MM). Using data from Preqin, the table below shows the yearly activity of sub-$100MM US funds over the past 5.5 years. Note that the data includes sub-$100MM fundraises for all funds, not just initial funds (i.e. Fund III’s would be included if they fall within the parameters of <$100MM and US). As the market has grown and evolved for new venture firms during this time, so has the temperature and characteristics of the emerging manager fundraising market. Headwinds and tailwinds exist today for hopeful emerging ventures managers. Despite the low yield economy and obvious ubiquity of technology, new managers face an increasingly saturated field, a weak liquidity environment, general fears of an economic downturn, and recently the highlighting of poor behavior by peers. Overall, the degree of difficulty of raising a Micro-VC fund is unquestionably higher than it was a several years ago. To provide some context on that statement, here are a few of my observations and thoughts about the current fundraising market: The length of fundraising cycle isn’t getting any shorter. In 2014, the average fundraising cycle from start to final close for a Micro-VC manager was 12 months. Today, the average fundraising cycle is closer to 18 months, and managers raising their first ever institutional fund should budget 1.5–2 years to raise their fund. There lies a large distinction for LP’s between new managers raising a first fund and experienced managers that have spun out from other venture firms. For first time managers with no prior institutional investing experience, the following should be expected: -Absent a long relationship with institutional- grade capital providers, a fund size of $10MM-$25MM (perhaps slightly more if multiple partners) is likely.Aiming for a $50MM+ target is ambitious and is something we’ve only seen a few first time managers reach. -An LP base that is likely to be made up entirely of family offices and High Net Worth individuals. With the growth in first time funds since 2012, institutional LP’s have significantly raised their bars for allocations, and are very unlikely to invest in in managers that don’t have prior strong and attributable track records. -Higher emphasis on authentic differentiation. I’d like to underscore the word authentic as the differentiation must...

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Micro-VC; Smaller is better, BUT the math is still really hard

Micro-VC; Smaller is better, BUT the math is still really hard

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture and start-ups. In 2012, the Kauffman Foundation released a report titled “We have met the enemy and he is us”. The report highlighted the lack of performance within venture capital and placed culpability on the investors (LP’s) of venture capital funds. One of the key findings in the study was compelling data that venture funds <$250MM performed significantly better than venture funds >$250MM — Based on the report, 83% of large funds ($250MM+) exhibited a return multiple of less than 1.5X, while only 54% of sub-$250MM came in at a multiple of 1.5X or lower (clearly a huge delta, although perhaps a bit of “we suck less”). The smaller is better message was heard loudly by LP’s as in the following years the venture market experienced both a significant downward shift in the size of funds from many brand name venture funds and a rapid growth in sub-$100MM venture funds as seen below (Prequin data). Along the way, the narrative of “small funds are better” morphed into a belief that attaining venture returns was only marginally challenging for small funds. Purely from a mathematically perspective, small funds certainly appear have a less daunting path to returning a multiple of investor capital. A notion that resonates strongly when considering the paucity of large exits over the last decade. However, the actual analysis is significantly more complex. First, it’s important to acknowledge that the risk/return calculus is quite different for small funds as compared to larger funds. Firms who raise sub-$100MM funds are predominately seed-stage investors (or Micro-VC’s). As a function of an investment thesis focused on seed investing, these portfolios typically have longer liquidity cycles and more risk than the portfolios of larger fund investors. When adding in the startup risk elements of investing in a first time fund and/or first time venture capitalist, an acceptable “venture return hurdle” is higher for Micro-VC managers. The same LP’s who happily would accept a 1.5X-2X cash return multiple from large, established fund managers usually look for 3X+ net multiple for smaller seed funds. As the data from Correlation Ventures shows, the most successful funds are those in the 90th percentile of their given vintage year. Yes, while being top quartile performer keeps you in the game, the best firms consistently have funds that are in the top decile. For Micro-VC funds, being in that top decile means fund performance of a minimum 3x+ net. If that’s the case, what does it take to achieve a good venture fund return for a Micro-VC fund? Over the years, we’ve heard many managers state that because their fund...

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Are LP’s still bullish on Micro-VC?

Around this time last year, we co-produced the inaugural RAISE summit, an event conceived by Akkadian Ventures and Core Ventures Group, and primarily developed to help foster venture fund entrepreneurship. With over 100 venture capital fund managers and 50 venture focused Limited Partners (LP’s) in attendance, the follow things became clear during the conference: An extraordinary amount of managers were raising first time funds, with an overwhelming number doing so without prior institutional venture investing experience. Most faced the same issues around raising a fund. The LP’s expressed intrigue into the Micro-VC class, but very few had really taken an active role in allocating. A year later, the Micro-VC market has evolved distinctly as I’ve covered in my recent writings.  As we near closer to the 2nd RAISE summit on May 10th, we decided to pre-emptively gauge the temperature of LP’s today toward Micro-VC. As such, we conducted a survey with a subset of LP’s that we know have invested into Micro-VC/seed venture funds in the past.  The sample size here was ~50 LP’s. The breakdown of the LP’s in the study was the following:   Below are a few of the questions that were posed in the survey: Takeaway:  It was surprising to see the high % that indicated they have an active mandate. This may be a result of the large concentration of Fund of Funds in the sample. Also, the term mandate may have left some room for interpretation. Interestingly, <40% of Endowments responded they had an active mandate for new Micro-VC allocations. Takeaway: 2016 was not an aggressive year for institutional allocations to first time funds. Only 4% of respondents indicated they had done at least 3 Fund I Micro-VC allocations in 2016 and 40% said they didn’t do any.   There a few reasons that likely drove this: Driven by fear of long winter, many large venture fund managers contracted their fundraising cycles and came back to market earlier. This flood of brand firms coming to market in the first half of 2016 exhausted many venture allocation buckets, and many new funds were pushed down the priority stack. The respondents in this study were primarily institutional investors, which generally tend to have reduced appetites for first time funds (many of which are raised by first time managers). The LP’s in the data set appear to be poised to be far more aggressive in 2017, with less than 10% indicating they’d do no first time fund investment during the year. Takeaway:  Historically, institutional LP’s haven’t incredibly excited about first time manager allocations as questions around both institutional investing acumen and operational firm management typically represent too great of risk.  That being...

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Why the Micro-VC surge will drive innovation across the US

The following was co-authored by Ezra Galston of Chicago Ventures (@ezramogee) and Samir Kaji (@samirkaji) of First Republic Bank. Please follow me samir kaji on Twitter and Medium for my thoughts on the world of venture capital. Over the last several years much has been made of the opportunity, or perceived lack thereof in technology centers outside of the Bay Area and NYC. From Steve Case’s Rise of The Rest Tour, to Google for Entrepreneurs, to Brad Feld’s Building an Entrepreneurial Ecosystem , the discussion has consistently been overwhelmingly positive. It’s easy to understand the stance as who wouldn’t want to support entrepreneurship, irrespective of geography? However, it’s hard to discern whether these opinions were borne out of a utopian desire or a sincere belief of true financial viability in markets outside of NYC and the Bay Area. In Fred Wilson’s widely discussed (and debated) piece “Second and Third Tier Markets and Beyond,” he suggested that the opportunity outside of the Bay Area was significant, citing the successes of USV in New York, Upfront Ventures in LA and Foundry Group in Boulder: “The truth is you can build a startup in almost any city in the US today. But it is harder. Harder to build the team. Harder to get customers. Harder to get attention. And harder to raise capital. Which is a huge opportunity for VCs who are willing to get on planes or cars and get to these places. There is a supremacism that exists in the first and second tiers of the startup world. I find it annoying and always have. So waking up in a place like Nashville feels really good to me. It is a reminder that entrepreneurs exist everywhere and that is a wonderful thing.” In an effort to move past anecdotes however, we wanted to explore one of the components that helps drive and catalyze early entrepreneurial activity in any localized geography — the availability of early stage funding. Simply put, non-core US tech hubs are reliant on local early stage capital to subsist since seed stage fund sizes often make remote investing impractical (by contrast growth stage investors who manage large funds and have significant resources can easily invest in breakout companies outside their region). With the hypothesis that quality local seed capital is needed to foster a strong entrepreneurial ecosystem, our analysis is centered on whether the MicroVC surge, has provided (or may provide) a material impact to these “2nd and 3rd” tier US geographies. Fortunately, there’s good news for entrepreneurs everywhere. Of all of the Micro-VC funds raised since 2010 (this number includes firms currently raising funds), over 40% of Micro-VC’s formed were based outside of the...

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