Follow me @samirkaji for my thoughts on the venture market, with a focus on the continued growth with the emerging manager landscape. As we move into month three of the COVID-19 outbreak, the impact on the global economy has been unmistakable, and arguably the most significant since the US came out of the last recession. Conferences have been cancelled (SXSW!), business travel has nearly grinded to a halt, companies such as Amazon and Twitter have asked workers to stay away from the office, and the public markets have encountered massive turbulence. Historically speaking, private early stage markets lag behind public markets by 12–24 months, and capital pullback typically occurs only after a sustained period of extreme volatility or downward shifting movement. And while it is far too early to understand the medium to long term effects of the virus on the private capital markets, companies (see Sequoia’s latest cautionary piece) and venture funds must start planning for a potential new reality. Over the last decade, the emerging manager ecosystem has gone from infancy to early maturity with over 1,000 firms having been formed since 2009 (and according to Preqin, there are 1,023 firms in market right now for a new fund). So what should emerging managers, the super majority whom are seed focused, expect when fundraising in 2020? A few items: Family office allocation disruption — In our late 2018 emerging manager survey, we found that 67% of the capital allocated to Fund I offerings were from family offices and high net worth individuals (53% for Fund II, and just under 50% for Fund III’s). Over the last 5 years, we’ve seen family offices as incredibly active (albeit opaque) participants in emerging fund allocations and in co-investments. While there certainly remain a large contingent of family offices with long histories of being as durable investors across market cycles, a material number of family offices just began investing in venture during the post-2009 period of economic prosperity. We should expect those in this latter group, particularly those whose family wealth has been generated from areas outside of tech, to retrench to varying degrees while waiting for some semblance of true macro visibility. I don’t believe that the paradigm has shifted completely from yield chasing to liquidity hoarding, but the pendulum is certainly swinging.Protracted fundraising cycles — From 2016 to 2019, the average time to fundraise for Micro VC firms dropped from 20 months to 16 months. With business travel partially suspended for many (also reducing the number of serendipitous touch points at industry events) coupled with general Macro anxiety, I’d recommend managers, particularly those with Fund I/II offerings to plan for an 18+ month cycle from initial fundraising launch. There will always be exceptions,...

Follow me @samirkaji for my thoughts on the venture market, with a focus on the continued growth with the emerging manager landscape. One of the most common struggles I encounter with fund managers is being able to optimally set a fund target. While this admittedly isn’t an exact science, there are some fundamental considerations that help guide this exercise: Commercial Viability Irrespective of the amount of capital necessary for a given investment model, managers must have a very good sense of the LP environment to be able to accurately assess viability of contemplated fund target. From our experience we’ve found that teams with prior institutional track have commercial viability of approximately $25-$35MM/partner (seed), $50MM-$100MM/partner (Series A), and $100MM+ (growth). With limited or no prior experience, the numbers drop to about $10MM-$20MM/partner at seed, with little to no appetite for Series A and later. This is why well over 85% of new firms formed over the last five years have been seed firms. Here is a recent post I published around ranges of fundraising viability based on manager profile. You can view statistics on average institutional backing by fund number and manager profile here. One quick heuristic test I encourage managers to do is to test viability by going to all of their strong 1st degree connections to determine how much can be circled with a high level of confidence (always discount using probabilities as the chasm between verbal interest and sub docs is HUGE). You generally want this to be at least 25% of fund target. Lower than typically comes with elevated risk of a fundraise that won’t meet target and will come with a whole host of issues like the manager chasing the wrong profile of LP’s and having to decrease fund target mid-fundraise (!). Min/max for investment thesis This exercise is to determine the Minimum Viable Fund (MVF) size necessary to execute on thesis while concurrently positing the outer band of fund size after which point the investment business model holds. The latter is often expressed as a hard cap on maximum fund size. The easiest way to determine MVF is to think carefully through portfolio construction. I.e. if the goal is to lead seed rounds with initial checks of $500K-$750K, with 20–25 companies, and a reserve ratio of 1:1, your MVF calculation would yield a fund size of approximately $20MM ($500K*20 companies)*2 (reserves). Any amount less than that would impact thesis and economic framework. Conversely, raising a $75MM fund would be well outside the outer band of this thesis, and would give rise to a completely different business model, with different competitive parameters, etc. I’d encourage setting a fund target that is no more than 1.2X of MVF with a hard cap that...

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...

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...

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...

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%...

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...

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...

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...

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....

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...

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...

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...

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture and start-ups.. In my last post, I illustrated the exit math necessary for a seed fund to generate a 3X net return multiple for its investors (LP’s). The portfolio construction of the fund used in the example is one that is most often seen for seed funds: ~30 portfolio companies, with about half of the fund reserved for doubling down on portfolio companies that show the most promise early-on. Having met or seen over 300 seed fund managers over the past 5+ years, we’ve observed that greater than 65% of seed funds have portfolio construction models that are very similar to the one noted above. This statistic is not all that surprising given the sound rationale that accompanies the model above along with the axiomatic nature of venture capital investing. While fund managers go to great lengths to differentiate on the basis of sector, stage, geography, brand, and value-add, they rarely steer from traditional structural items such as portfolio construction and economics. This is likely in part driven by LP’s, who historically have favored convention over innovation when it comes to the structural elements of venture funds (sidebar: I think LP behavior plays prominently in reinforcing some of the perverse behavior that permeates in venture investing, but that is to be saved for another time). However, in an industry where risk adjusted return performance for 75% of funds is middling to poor, it begs the question whether standard seed fund portfolio construction should be further evaluated as perhaps one of the contributing factors of poor performance. It’s well known that venture investing is inherently risky and many controllable and non-controllable variables determine fund success. As such, it’s imperative that venture investors not just what these variables are more importantly how they specifically correlate to their own investment models — — With the number of exogenous factors that affect startup success and the right skew of the value creation curve, venture investing is certainly a probability based vocation. The best VC’s are ones that construct methodologies that continually tilt the odds in their favor. Given that optimal portfolio construction is an unmistakably driver of fund success, let’s come back to it now. Despite the fact that non-standard portfolio construction models are often criticized (i.e. terms such as “spray and pray” are derisively used for highly diversified/low ownership portfolios), it stands to reason that standardized portfolio construction model may sub-optimize the probability and magnitude of fund performance if other specific fund factors aren’t considered first. Fund managers should instead decide on portfolio construction as a function of a thoughtful analysis of firm strengths/weaknesses, investment...

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...

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...

Follow me @samirkaji for my always random, sometimes relevant thoughts on the world of venture investing and startups. Over the years, I’ve spent a lot of time studying and chronicling the Micro-VC (or seed funds for those who prefer) In my post from last October titled “The Micro-VC surge won’t stop” I discussed the continued development of the Micro-VC space, and briefly mentioned the growth we’ve observed of what we deem as “Nano-funds”. As a refresher, I defined Nano-Funds as owning the following characteristics: -Seed stage focused venture funds that are <$15MM in size. -Typically started by managers with limited or no prior venture investing experience. -Serve as a “proof of concept” fund for the venture manager’s investment hypothesis, investing acumen, and ability to manage a venture firm. -Limited Partner bases that are either wholly or primarily made up of high net worth individuals and small family offices. -Often act as a co-investor versus a true lead/anchor investor. If a Nano-fund regularly serves a lead investor, it’s likely they are primarily investing in pre/early seed rounds. Over the past year, we’ve observed an increasing number of firms coming to market are starting with Nano-funds (in some cases, the initial fund target is higher than $15MM, but the fund ends with a final close that is south of that). To test whether that observation was simply anecdotal or not, I want to examine the Nano-fund trend a bit more comprehensively. First, let’s take a quick look at the # of new Micro-VC’s firms formed by year. Note this study only includes Fund I offerings, and thereby are all brand new firm formations. The numbers below are from data culled from Prequin, CB Insights, SEC Form D filings, and our own private tracking database. Now, let’s examine the % of new Micro-VC funds we’d put in the Nano-fund category by year. Again, only Fund I offerings were used in this dataset, and while some of the funds used in our dataset are still fundraising, we used what we know to be the current closed amount. We removed funds that we didn’t have current information on. The chart above clearly illustrates the material growth in the number of Nano-Funds as a % of new Micro-VC firms every year (33.4% in 2014 to 47.9% in 2016). We believe that this trend stems primarily from the following factors: -Institutional Limited Partners that have significantly raised their bars for Fund I offerings, and have a general preference not to invest in first time managers. -The reliance on high net worth individuals and small family offices. The small check sizes associated with this group of LP’s forces many managers to settle...