Blog Archives

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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#LongLA – LA Venture is underrated

#LongLA – LA Venture is underrated

Follow me @samirkaji for my always random, sometimes relevant thoughts on the world of venture investing and startup (the below is a repost from an article I posted on CB Insights) When ranking US startup hubs, it’s widely accepted that New York City stands out clearly as the largest venture ecosystem outside of Silicon Valley. Startup formation and funding data seems to confirm this notion as the area consistently ranks as the second-largest region fortotal venture capital funding. Although the region was weighted down by unrealistic early expectations, it’s easy to build a bull case for NYC. Just check out a sampling of private companies that have originated out of New York including Betterment, WeWork, Oscar,Bonobos, Kickstarter, and Sprinklr. Undeniably, a strong list and one that promises to grow over time. On the other hand, all the way across the country, Los Angeles remains a bit of an enigma for those attempting to evaluate it as a standalone hub. Perhaps it’s LA’s proximity to Silicon Valley or its reputation as a region that’s strictly media-focused. Either way, many continue to question the region’s ability to become a long-term, standalone venture capital and tech hub and often view it as a remote extension of Silicon Valley. Having spent a lot of time in the area over the past few years, I’m very excited about LA becoming a legitimate startup and venture hub. With universities like UCLA, Cal Tech, UC Irvine, and USC churning out high-quality tech talent and developing tech communities in Venice Beach and Santa Monica, startup formation continues to rise in the area. Accelerators and co-working spaces have also become ubiquitous, and companies such as Google and IBM have set up nearby campuses, a direct byproduct of the area’s talent pool. Throw in the desirability of living in the area and it’s easy to see why we’ve witnessed so much recent positive momentum. Of course, the items above don’t completely answer the question of whether LA has drawn a short straw in public perception relative to regions like New York City. A key metric for any legitimate start-up ecosystem is the quality of companies that originate in the area and by extension, the number of successful exits. To measure this, we pulled LA-based startup exit data from 2011 to 2016 using CB Insights. For comparison purposes, we juxtaposed this against exit data for companies that originated in NYC during that same time period. As seen in the chart, New York City consistently demonstrated more (disclosed) startup exits over the last five years. Given the amount of venture funding and company formation in NYC relative to Los Angeles during the identified period, it’s not...

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The Micro-VC surge just won’t stop

  Follow me @samirkaji for my always random, sometimes relevant thoughts on the world of venture investing and startups. Although I spend most of my days closely tracking the emerging venture capital market, I almost fell of my chair when I came across a report from Prequin that noted that nearly 500 first time Micro-VC funds were currently in the market (the vast majority being US based). Micro-VC slowdown does't appear to be happening. According to @Preqin data, there are 470 1st time Micro-funds raising today globally..wow. — samir kaji (@Samirkaji) October 12, 2016 If only half of these managers are successful in closing a fund, we’d still have 600+ active Micro-VC firms globally, with over 80% having been formed post-2009. A couple of years ago, I projected a mass consolidation of the market by 2020.While still likely, it’s become evident that the number of active Micro-VC funds in 2020 will be far above the 50 or so I had projected. Based on the responses from my tweet, it appears that many venture insiders were equally as shocked. Sweet mother of [insert preferred deity here] https://t.co/KtmHz5zgAS — Paul Kedrosky (@pkedrosky) October 12, 2016 @Beezer232 @Samirkaji @Preqin pic.twitter.com/fUH64c301o — Paul Arnold (@paul_arnold) October 12, 2016 As a refresher, Micro-VC firms are venture firms that typically have the following characteristics: 1/The super majority of fund investments are pre-Series A (somewhere within whatever is called seed today). 2/Invest on behalf of 3rd party Limited Partners. 3/Most commonly have fund sizes that are sub-$100MM. From a general partner perspective, Micro-VC funds are typically raised by individuals from 1 of these 3 profiles (note in some cases, individuals/teams have a combination of the below). 1/Individuals spinning off from other firms 2/Former operators/entrepreneurs 3/Successful angel investors Let’s examine some of the trends we’re seeing today: Jump in “mini Micro-VC” firms An important nuance when thinking about new Micro-VC firms is distinguishing the difference between a “first time fund” and a “first time manager”. A first time fund represents a firm with a Fund I offering, but has at least one partner that has worked at an institutional venture firm in the past. A first time manager is a new firm with a Fund I offering where none of the partners have had significant experience working at a venture firm (or if they did, it was in a pre-partner/principal role). For most firms that fall into the first time manager bucket, attracting institutional or semi-institutional capital is an incredibly difficult endeavor. As such, these managers must primarily rely on High Net Worth individuals and small family offices in their network to back them. Given the small dollar sizes generally allocated by...

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Venture Observations 2016 — Tweetstorm version

Follow me @samirkaji for my always random, sometimes relevant thoughts on the world of venture investing and startups. As we move closer to Labor Day (amazing how quickly this year has gone), I wanted to share a few observations we’ve seen within the world of venture. I may expand on a few later, but in the interest of time and ease of digestion, I’ve listed my thoughts tweetstorm style below— Yes, I may have hit >140 characters on a couple below. 1/No slowdown in Micro-VC formation; we have observed 77 new first time funds in 2016 (some still raising) 2/New Micro-VC’s w/no prior inst. investing experience should expect no inst. LP’s/target $20MM or less. 3/Opportunity funds more common; i.e.DCVC, SoftTech, Lightspeed, Eclipse, Homebrew (2015), Industry, E.ventures 4/1H16’ massive fundraise year; many funds held dry closes; anticipatory raises to guard against potential sig market downturn 5/Established inst. seed funds going larger and often play later in seed process. Post-Seed/early A hot area right now. 6/Harder to raise on either end of funding barbell (late stage; pre-seed). Seems $1MM ARR is bar for inst.seed SaaS rounds 7/Incongruence of private markets (growth focus) and public markets (profitability) very remains prominent. 8/Anecdotal, but we are seeing far less SPV’s being created for B+ round deals. 9/”Unicorn” market very top heavy; 50% of unicorn market cap can be captured in top 12 companies (Uber,Xiami,Airbnb top 3) 10/Leveraging of technology within venture firms; proprietary tech at firms like Goodwater, Signalfire, Eventures. 10/Low yield environment/recent exits (Jet/Nervana/DSC/Cruise/Twilio IPO) bring hope of a relaxing liquidity sphincter in priv. mkts 11/Diversity in venture much more prevalent in seed stage firms 12/LA venture fund ecosystem heating up with new entrants;i.e.Refactor/Fika/Alpha...

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The different types of Seed VC’s

Please follow me @samir kaji for my random and occasionally relevant thoughts on venture capital and technology. Stemming from the venture pullback that started in late 2015, it’s been one of the toughest years in recent times for companies seeking seed capital from VC’s this year.  The good news for companies seeking seed venture funding is that with the with a record number of new institutional seed funds and what appears to be shaping as a monster fundraising year for VC’s, the slowdown may be short-lived. A critical consideration for founders when developing seed fundraising strategy is being able to accurately map out the market to determine what type of firms might be a good fit for your company. The table below provides some characteristics of venture firms, bucketed by size (fund size provides a great clue of investor behavior and thesis). A few things to note first: -Things like initial fund size only refer to seed.  For example, NEA’s average initial investment across all investments is not $2MM and below, but that’s where they usually play when invested in seed stage companies. -There are of course exceptions, as the table is meant to provide generalizations that most often are true. -Some of the ranges below are fairly large.  The closer a fund is to the bottom or top of the range, the more likely it operates similarly to venture grouping it borders. Fund Size  $0-±$15MM“Nanofunds” ±$25MM-$75MM“Micro-VC”  ±$75MM-$200MM“Early stage” funds ±$250MM and over“Lifecycle” funds  Primary Investment Stage Pre-seed & Seed Pre-seed to Post Seed Post – Seed & Series A Series A and above Invest in Seed? Yes Yes Yes Often, but not all do # of partners at firm Usually 1 1-3 2-4 4+ Typical initial investment (refers to seed only) $150K-$250K $500K-$1.5MM $1MM-$3MM $500K-$2MM Who you get from firm? General Partner General Partner General Partner or Principal Principal or below Take a BOD seat at seed? No Sometimes Sometimes, and usually during large post-seed rounds No Leads rounds? No, usually just a co-investor Sometimes Yes Sometimes Investor Participation level? Medium High High Low Usual valuations paid (seed only) $4MM-$7MM $4MM-$10MM $4MM-$15MM $4MM-$20MM Examples of firms (based on prior/current fund) Array VC645 VenturesFuture-PerfectRubicon VCFemale Founders Fund LemnosMerusMuckerCowboyBullpen Capital SoftTechForerunnerFelicisFloodgateRibbit Capital NEASequoiaAccelUpfrontEight VC Kleiner...

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Venture Capital’s diversity problem is being solved by Micro-VC’s

Venture Capital’s diversity problem is being solved by Micro-VC’s

Follow me @samirkaji for my random, sometimes relevant thoughts about venture capital As expected, when Cyan Banister joined Founders Fund in March of this year, most of the headlines focused on the firm bringing on its first female partner. Although the emphasis probably should have been focused on the firm bringing aboard a tremendous talent who will invariably play a big role in delivering value to the firm, I realize that driving awareness of gender inequality remains an unfortunate reality of our industry. There’s no secret that the venture capital industry has always struggled with gender balance and diversity in general. As of April 2016, only 7% of investing partners at the top 100 firms were female, a number that sadly has not shifted much over the past decade. Even more startling is that many top venture firms still do not employ a single US based female general partner. The intention of this post is not to posit about venture capital’s gender inequality problem. In fact, I think too many people mistakenly perfectly correlate gender balance with healthy firm diversity. It doesn’t. The truth is real diversity is a function of individuals that, through unique backgrounds and experiences, can bring forward authentic diversity of thought to the firm or to the industry as a whole. In practice, it’s possible that an all-male investment team is better diversified than a team that is completely gender balanced, particular if the latter includes individuals of the same socio-economic backgrounds. Of course, diversity of thought inherently usually accompanies teams that actively promote a healthy balance of ethnicity, gender, and age. The shift to creating healthy diversity within traditional venture firms has been slow, albeit a shift that is gaining momentum as more firms realize the need to bring significantly different perspectives to the table. However, tall hurdles within traditional firms (legacy bias, difficult of breaking into a partnership, politics, etc.) remain in place that slow the pace for diversity within venture. It’s unfortunate. To truly drive the next generation of innovation we need entrepreneurs and investors that that have real capacity to view the world through a different lens. Additionally, as venture capital returns typically come from a relatively small subset of companies each year, becoming a great venture firm requires consistently seeing opportunity when others see nothing. As many in the industry have commented, some of the best companies ever formed were initially viewed as terrible ideas by the masses. It’s hard to identify these opportunities if everyone within a firm ascribes from the same school of thought. Fortunately, the world of Micro-VC (firms that raise funds <$100MM) isn’tshackled by the same constraints of traditional venture and...

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The Micro-VC crunch?

Follow me @samirkaji for my always random, sometimes relevant thoughts on the world of venture investing and startups The escalating difficulty of raising Series A capital in recent years has forced many companies to have to raise multiple seed rounds. Terms like pre-seed, seed, post-seed, and seed extensions are commonplace lexicon in early stage financing. Fortunately for companies going through the multiple seed round path, this phenomenon has coincided with a dramatic increase in small seed stage venture funds entering the market. The success of first generation micro-VC firms like Lowercase Capital, Felicis Ventures, and Baseline Ventures has helped pave the way for growth we’ve seen in the sector. We count roughly 300 US micro-VC firms today — a 2x+ increase from September 2014. As is the case with companies that must navigate through the seed ecosystem prior to getting traditional A round financing, most micro-VC funds follow a similar path. Absent a long institutional investing track record or an objectively apparent revolutionary model, the road map for new micro-VC funds has been fairly consistent: Raise a small proof of concept fund of $5MM-$20MM through individuals and family offices and then hope to show enough portfolio traction to enable a larger institutional investor backed fund 2–3 years later — the micro-VC version of a Series A round. Institutional backers are almost always necessary for scale and sustainability of venture firm. To note, the proof of concept fund moving to institutional fund process in micro-VC isn’t new. Jeff Clavier’s (SoftTech) first fund was under $1MM and Chris Sacca’s first Lowercase fund was under $10MM (congrats to all those fortunate enough to have invested in that fund as it remains the best performing fund of all time). From 2010–2015, the proof of concept to institutional backed fund exercise was fairly straightforward. Managers that had demonstrated strong early performance through mark-ups and had built decent relationships with institutional investors had little to moderate difficulty attracting institutional backers for their sophomore funds. However, the market today is decidedly differed and most institutional investors have slammed on their handbrakes with respect to allocating to new micro-VC funds. A few primary reasons exist for this: – The glut of funds in the market has driven the bar for institutional allocations much higher and the amount of portfolio traction/differentiation needed to get capital from a fund of funds or endowment is very high. – Many institutional limited partners have made their bets within the micro-VC sector and are content in letting performance play out with existing managers. – Limited proof points. After 2 years, managers have little more than a few markups and anecdotes to show as proof of concept. With the reset of venture...

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Investor intros – Get rid of the buzzwords!

Investor intros – Get rid of the buzzwords!

As I’ve written about in the past, entrepreneurs can significantly increase their chances of getting funded by mastering skills as rudimentary as writing emails to potential investors. In hindsight, I failed to highlight the importance of entrepreneurs being able to effectively narrate what their company actually does. While admittedly this falls into the category of “duh, obviously”, I’m still seeing too many talented founders fall into buzzword purgatory when describing their company. Here’s an example of an email I recently saw from a founder soliciting investment (For confidentiality, I’ve changed the name/business model, but left in the buzzwords):  “Healthchat is a disruptive multi-dimensional cloud based platform that provides a transformational offline and online experience via highly curated social communities within the healthcare, wellness, and medical sectors, while providing enterprises with access to valuable, granular level big data analytics.  Led by (Insert name) and advised by top healthcare expert (some brand name), our innovative technology promises to deliver a best of breed solution to the multi-billion dollar healthcare vertical.” These types of descriptions drive investors crazy and do a massive disservice to the entrepreneur and business. The most common reaction investors have to emails like this is, “Hmm. I have no fricking idea what you do”. And instead of replying with clarifying questions or a request for a meeting, investors often ignore or delete these emails altogether. The rationale is if you can’t easily describe your business and mission to me, how can you possibly sell it to prospective customers and employees? Fortunately, this is something that’s easy to remedy. Here are a few ways: Eradicate common buzzwards from your vocabulary We tend to rely on them too much (myself included), but they end up serving as meaningless fillers, distract from the message, and are discounted anyway. Here are some of the words that you should do your best to avoid: – Disruptive – Viral – Big Data – Next generation – Best in breed – Differentiated – Platform – Transformational – Innovative – Unicorn (please, please never use this). Write the email as if the investor is dumb While of course this isn’t (usually) true, you must assume that he or she knows nothing about the business and needs a “your company for dummies” version. Keep the company description simple and short with the following structure: -Team: Who you are (1 sentence) -Problem: The problem you are solving, and why (1-2 sentences) -Product: What your solution is (1 sentence) -Market: Who would use it or who is using it, and who will pay for it (1 sentence) Here’s an example of this using the fictitious company described above:  “With a founding team comprised of...

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The market reset and Bank Venture Debt

Please follow me @samirkaji for my random, sometimes relevant musings on venture capital. “If one of my companies is taking on venture debt from a bank in today’s market, will they f*ck me by not letting me borrow the money when I need it?” It’s a question that a investor recently posed to me.  While blunt, it’s wasn’t an unreasonable question to ask when the private markets have started to see a marked reset. To be clear, in conjunction with a fresh equity raise, venture debt remains an incredibly cheap, non-dilutive way to extend runway and/or support growth. Over the last few years, the price of bank issued venture debt has dropped dramatically, leading to a surge of companies taking on bank debt financing shortly after an equity raise. Now going back to my friend’s question. For reference, most venture debt deals allow for some period of time (6–18 months) during which a company can draw capital. Traditionally, companies opt to draw down capital close to the end of the draw period to reduce paying interest on cash they don’t yet need. However bank issued venture debt often comes with what is referred to as a “contingency funding clause”, which allows banks to reject a draw down request subjectively in its own sole discretion. In the past, companies and investors haven’t worried too much about this clause, but many boards have recently begun to instruct portfolio companies to draw down capital immediately after the venture debt deal is inked to avoid a catastrophic situation of not having access to debt capital when it’s most needed. While banks haven’t historically activated this clause, boards are right to have some consternation. Nearly all venture debt banks are publicly traded and highly regulated, and it’s possible that if things get really messy, we may see more aggressive bank behavior, especially in situations where: – The company has missed any significant milestones. – The company doesn’t have a “name brand” investor syndicate (banks will go to great lengths to avoid relationship and reputation risk with the top VC firms). – The draw request comes at a time where the company has < 6 months of runway, inclusive of the debt draw, without a defined path to further funding. While the counsel of an immediate draw has some merits, there are some inherent flaws to this line of thinking: 1/ It results in paying interest on cash that you already have on the balance sheet from your equity round. 2/ The utility of the debt is significantly reduced if you have to pay back 25%-33% of the line before you would theoretically need it. If this happens, the cost of...

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Another Measure of Seed Fund performance

Another Measure of Seed Fund performance

Follow me @samirkaji for my random, sometimes relevant thoughts on the world of venture capital.  Paul Arnold, founder of seed stage firm Switch.VC and I wrote recently about the impact of seed funds in securing follow-on financing. That post aimed to help founders pick the seed-stage funds most likely to help them secure later financing. This second post adds detail and perspective for seed-stage focused General and Limited Partners. Leveraging data from CB Insights, we created League Tables that identify seed funds with the top follow-on rates each year. With the current array of emerging managers and compressed fundraising cycles, GPs and LPs must use intermediate measures to benchmark fund performance—cash-on-cash returns simply aren’t known until it’s too late. Measures like Internal Rate of Return (IRR) and Total Value of Paid in Capital (TVPI) are used to grade funds in their middle years. We believe that follow-on rates are also a core metric and critical to understand a young fund’s performance. High follow-on rates are fairly well correlated with high Investment Multiples and IRR. While benchmarks for Internal Rate of Return and Investment Multiples are readily available, the data for follow-on funding has been fairly limited. GP’S AND LP’S: FOLLOW-ON RATES MATTER GENERAL PARTNERS General Partners want to know how to drive fund results in early years. They want to track whether they are performing and need to measure the early signs of long-term returns. And most managers are seeking to build a long term franchise with successive funds. How should a GP drive follow-on results? Aside from picking good companies and making them more valuable, they need to be systematic in helping secure the next round. This means preparing startup founders for their next raise, clarifying financing milestones, and building rapport between founders and the best downstream investors. GPs should know when a deal is right for other firms and build a reputation for bringing them the deals they want to get into. Follow-on investments validate a seed fund’s early bets. It’s evidence for your strategy. And in a rough-and-tumble year like 2016, it shows that your portfolio and approach is strong enough to navigate a tighter market. LIMITED PARTNERS Limited Partners want to know which new fund managers will be tomorrow’s winners. As Cambridge Associates writes, for the last 10 years, “40–70% of total gains were claimed by new and emerging managers, a clear signal to investors to maintain more constant exposure to this cohort.” But identifying the best new managers is not easy—the best can come from unexpected backgrounds and with completely novel strategies—and many LPs say they struggle to separate signal from noise. In this context, a high follow-on investment rate...

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Why follow-on rates for seed funds matter

This is a re-post from an article Paul Arnold and I from Switch Ventures authored for CB Insights. Follow me @samirkaji for my random, sometimes relevant musings about the world of VC and startups. Institutional seed capital is an invaluable source for startups. As the number of institutional seed-stage firms, often referred to as micro VCs, has ballooned, founders have many choices of seed investors. According to our database, there are nearly 350 micro VC firms in the US that focus on bridging the gap between angel funding and Series A rounds. This influx of seed capital makes the decision process for founders difficult. A founder must pick investors that not only can help the company reach critical milestones, but also help them secure their next round. Why follow-on rates matter Follow-on rate is strong evidence that an investor is not only adept at picking good companies and adding value to their portfolio companies’ operations, but also at guiding a company to downstream investors for the next round of financing. Note that most micro VC firms only participate as a lead or co-lead in the seed round. Founders want to build big, iconic companies. To scale and capture a big market usually requires an escalating series of capital investments. The biggest hits almost always follow this path. While exceptions like Veeva exist, it remains rare to build a company of scale without securing many rounds of financing. Today, follow-on rates matter more than ever. The economic reset that we’re experiencing has created choppy waters for all stages of startup funding. Macro instabilities caused many investors to pull back on capital deployment (and valuations), and to require more traction before investing. Micro vs. traditional fund performance We analyzed follow-on rates for seed-stage VCs using data from CB Insights. Since larger seed-extension rounds often serve as Series A rounds, we considered a follow-on round to be when a subsequent financing was greater than $2.5 million, regardless of how the round is otherwise labeled. We netted out any companies that were acquired prior to additional funding. The table below lists follow-on rates for institutional seed-stage investors for vintage years 2010–2014 (2015 was statistically irrelevant as most seed rounds offer 12–18 months of runway). Traditional venture funds are those that employ a strategy around investing in seed-stage companies (i.e. Formation8, Crosslink Capital, Founders Fund, etc). Several fascinating insights stand out to us from the data above. Micro and traditional VC have nearly identical follow-on rates. Despite some founders’ sense that it’s best to raise seed from the larger funds, the evidence doesn’t bear it out. Institutional micro VCs are securing follow-on for their portfolio with at least the...

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Venture Capital takeaways from the RAISE Micro-VC summit

Follow me @samir kaji for my random, sometimes relevant musings about the venture capital world. Last week, we were fortunate enough to serve as one of the co-producers ofRAISE in the Presidio, a 1-day summit focused on helping emerging fund managers build lasting venture franchises. Much credit for the event goes to Akkadian Ventures and Core Ventures Group, who spearheaded the event along with fellow co-producers Top Tier Capital and Weathergage Capital. To ensure candid and open conversation, attendees of the event were asked not to share sound bites or any specifics on social media. While I won’t share exact specifics, I do want to want to share some of my main takeaways from the event. LP’s are really busy A few factors are driving this. The first is that the fundraising cycle for venture firms has significantly truncated over the last few years. Instead of a new fund every 3–4 years, firms are now coming back to market every 2–2.5 years. Recently, this phenomenon can be explained by venture capitalists wanting to secure dry powder during what appears to be the start of a declining valuation environment (before market factors force LP’s to retract significantly). Irrespective of the current market, it’s clear that firms are pulling on LP purse strings more frequently than we’ve historically seen. Next, first and second time funds continue to flood the market (according to my data, there are 350+ firms in the US that can be considered Micro-VC firms). A few LP’s shared with me that they see between 5–10 new managers every week! Add in Opportunity funds and Special Purpose Vehicles, and it translates to an incredibly chaotic time for venture allocators. Market downturn isn’t a deterrent to new managers, but fundraising is incredibly difficult At the event, there were over 100 general partners, and over half of them were in process of raising their first institutional fund (or first fund of any kind). While the market reset is certainly dominating venture headlines, it doesn’t appear to be stopping new managers from raising funds. That said, very few institutional investors expressed that they were currently investing in first time funds unless it included a manager who had previous experience and success managing third party capital. Reliant on family offices and individuals for capital, most new fund entrants face the market reality of longer fundraising cycles and rolling closes (the average new fund has 3+ closes during a fundraise). Differentiated strategies abound Unlike 4–5 years ago when most Micro-VC firms were generalists by nature, the majority of managers present at the summit were thematically precise with respect to investment thesis (i.e. Government tech, fintech, materials, hardware, marketing tech,...

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Micro VC 2.0: the different flavors of Micro-VC

Micro VC 2.0: the different flavors of Micro-VC

A couple of years ago, the team at Bullpen Capital astutely observed that seed round financing had evolved from a single event to a multi-stage, continuous process. In general terms this meant that unlike in previous years, companies often needed to raise several seed rounds before closing a traditional A round. Terms such as Pre-seed and Post-seed became parts of mainstream vernacular, and each point of the seed process exhibited unique investor and company profile characteristics. The reason for this shift could be largely explained through the breadth and diversity of seed stage funding options that had become available to entrepreneurs — Angels, traditional venture firms, platforms, and seed firms of all sizes presented themselves as viable sources of capital to companies seeking seed financing. Analogous to the increased complexity of seed financing market is the now extremely intricate nature of the Micro-VC landscape. As I’ve written about extensively in the past, the rapid growth in the number of new seed stage focused Micro-VC firms over the past few years has been nothing short of staggering, outpacing even the most aggressive numbers that some within the industry have prognosticated. The chart below outlines the growth of Micro-VC: * Using CB Insights and personal tracking data A confluence of factors has driven this growth, including: · Increased emphasis by LP’s in investing in smaller, emerging venture firms. · Continued cost efficiency for very early stage startups, leading to record company formation #’s. · Compelling data that evidences superior returns for emerging funds. · Glamorization of the VC industry, leading to a desire for many to start venture franchises. · Strong interim performance data buoyed by dramatic mark ups. · Ubiquity of technology solutions that now exists across every major industry vertical. Up until recently, I’ve conversationally grouped the 300+ firms together in the broad bucket of Micro-VC. Similar to the aforementioned shift in seed financing, defining Micro-VC as a singular and heterogeneous entity simply no longer serves as a useful representation of the rapidly maturing market. For entrepreneurs seeking to raise seed capital from these firms, it’s an incredibly importance nuance to understand prior to fundraising. As I view the landscape today, the Micro-VC market is distinctly trifurcated, with three clear groups of firms present. Proof of concept funds With the sheer explosion of firms mentioned above, the bar for raising capital from institutional Limited Partners (primarily endowments, large family offices, and Fund of Funds) has become increasingly difficult for new entrants. Absent a long and successful institutional track record of investing, most new managers must demonstrate the ability to perform as an institutional investor under the firm’s thesis prior to receiving allocations from sophisticated institutional LP’s....

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The Best Kept “Secrets” of Venture Capital

The Best Kept “Secrets” of Venture Capital

Follow me @samirkaji for my random, sometimes relevant musings about venture capital. I’m a big fan of the question and answer site Quora and think it’s an especially great resource for entrepreneurs and investors. Earlier this year, I ran across this great question posted by an anonymous user: “What are the best-kept secrets about venture capital? If you have some free time, I’d encourage you to check out all of the responses, as several are extremely insightful. I’m reposting my (slightly expanded) answer below. · Fewer than 20% of venture capital funds provide the level of risk and duration adjusted returns that meet Limited Partner expectations (2.5X+ cash on cash return). · Even fewer individual venture capital partners (<10%) meet Limited Partner expectations. · However, the top 1% of venture capital funds can be transformational for the investors that are lucky enough to invest in them — Think Accel IX (Facebook) or Lowercase Capital’s first fund (Uber & Twitter). · It’s a relatively tiny industry compared to other asset classes, with only about $30B going to venture firms per year. Private Equity Buyout firms by comparison raise nearly 10X as much. · As counter-intuitive as it may seem, bull markets bring a whole host of unique challenges to VC’s. Apart from balancing fund deployment pressures while maintaining valuation discipline, capital becomes a marginally valued commodity by the best companies and entrepreneurs. No longer can “value-add” simply be something abstract, but needs to be definitive and authentic. · Fundraising sucks for them VC’s too, perhaps even more. With the exception of 50 or so firms, fundraising tends to be a long, frustrating campaign that can span 12 months or longer. · It’s not a sure path to untold riches. In fact, the industry is littered with tenured venture partners who have yet to receive a carry check (carry is the VC’s share of a fund profits). · Shiny objects matter to VC’s, too. Regardless of valuation, it’s it’s great PR for a firm to have name brand companies like Uber or AirBnB in their portfolios. · It’s a really, really long term commitment. Most funds these days, while structured as 10-year vehicles, end up surviving 14+ years before the last company is even liquidated. During that time, VC’s are on the hook to constantly update LP’s, provide financial reporting, and do all the not- so- fun stuff that comes with running a fund. · Economics are rarely shared equally at firms. 1st generation partners usually enjoy the bulk of carry and firm governance (a primary reason generational planning has been such an issue within venture capital). Benchmark Capital, which employs an equal carry structure for all partners...

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Decoding the Institutional Seed Stage Wine List

Decoding the Institutional Seed Stage Wine List

Over the years I’ve become a wine enthusiast of sorts. Although I’m nowhere near a connoisseur, I genuinely love sampling new wines whenever given the opportunity. However, more often than not I’m presented with encyclopedia sized wine catalogues when dining out. Like most things in life, options are great but only up to a certain juncture. Even well educated wine drinkers (not myself) can get tripped up when there are too many choices. For entrepreneurs, raising a seed round from VC’s in today’s market can feel similarly confusing. Along with the slew of larger traditional venture funds that dabble in seed stage investing, there are now nearly 300 “Micro-VC” firms dedicated to investing at the seed stage. The chart below provides a trend line of the approximate number of Micro-VC firms in the market. Institutional Seed Stage funds by year (“Micro-VC”) June 2015 – based off my tracking of Micro-VC funds. As is the case when choosing a type of wine, choosing the right venture partners is a highly personal choice, and requires a sophisticated understanding of your company’s needs to determine optimal investor fit. Of course, the downside of picking an incompatible funding partner is exponentially higher than choosing the wrong wine (although I’m sure that statement will upset a few sommeliers out there). To decode some of this confusion, there are some basic items that entrepreneurs should consider when evaluating potential institutional seed stage investors. 1/ Can you lead my round? Frequently, I see entrepreneurs spending countless weeks courting prospective investors only to discover that those investors will not participate until a lead investor comes in. A lead investor is any investor that anchors a round of capital, typically by setting terms of a priced round, or in the case of a convertible note, writing the largest check. For smaller investors, lead investors play the important role of representing the investor base as it relates to company building and tracking activities. While it’s rational to assume that every venture firm regardless of size can lead a round, it’s no longer always the case, particularly within the Micro-VC market. Through an analysis of roughly 250 institutional seed funds that I tracked through 6/30/15, nearly ~48% had fund sizes that were $25MM or under (many of which were sub-$15MM). Many of these firms don’t have the ability to truly lead rounds, and instead rely on a syndicate partner to act as lead. While these smaller firms can be great partners, it’s important to recognize that closing them will often mean securing a lead investor first. Also note that institutional lead investors can help galvanize a round by using their network to secure a large...

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Thoughts on raising a Micro-VC firm

(repost from innovation.firstrepublic.com) From San Francisco to New York, more than 250 micro venture capital firms now actively invest in early stage startup companies. Micro VC firms, which typically raise funds under $100 million, represent an extremely valuable option for entrepreneurs seeking the strategic financing and expertise to help grow their businesses. To better understand the micro VC market, and to identify some best practices for new managers seeking to raise their first fund, Kathryn Gould, Co-Founder and former General Partner at Foundation Capital, and Ashmeet Sidana, Founder and Managing Partner of Engineering Capital, offered a fresh look at the space and what it means to launch a new micro VC firm in today’s market. When it comes to the micro VC sector, how did we get here and how did we come to have so many? Kathryn Gould: The increase in number of funds can be traced back to the 2008 financial crisis, the subsequent increase in liquidity and complete lack of yield from the global financial system. During this time, Silicon Valley, and more broadly, startups, were perceived as one of the few areas of growth. Money rushed in, leading to an unsustainable increase in the number of funds. Another important enabler is that the cost of starting a company dropped dramatically due to the success of lean startup methodologies… though the cost of scaling a company has arguably increased. Additionally, high-quality limited partners became more comfortable backing a single general partner, recognizing the benefits of not having a large partnership-overhead. Finally, several established partnerships went through large rounds of fundraising making it difficult for them to commit to and help entrepreneurs at the truly formative stage. All these trends created a gap that has been filled by a new class of professional, but small, partnerships — the micro VC. Fundraising can be very challenging for first timers; what advice would you give general partners on formulating a fundraising strategy? Ashmeet Sidana (@ashmeetsidana): Identify an experienced mentor. I was fortunate to have Kathryn as a mentor helping me start Engineering Capital. Kathryn is an experienced venture capitalist. She is one of the rare people who has helped start multiple venture firms, which gives her a unique perspective on the landscape. Whoever you choose as your mentor, be sure that they have well-rounded experience in the field. Gould: Identify your differentiation from all the existing funds you will be competing with, and then make a compelling case for the value you will add. [The idea is that] the best entrepreneurs will choose you over established brands. But without a crisp differentiation and compelling value-add, it is too late to start a first-time fund in Silicon Valley. What would you...

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The Venture Capital Treadmill

The Venture Capital Treadmill

Follow me @samirkaji for my always random, sometimes relevant thoughts on the world of venture capital and technology. Building a great company requires many different facets. Most importantly, it requires a talented team with great conviction to build toward an incredible vision. Of course, building a company requires capital. Capital can come from many areas ranging from angels, friends and family, cash flow from operations (yes, it does happen on occasion), and from VC’s. While many entrepreneurs seem to have a love/hate relationship with VC’s, most resign themselves to the fact that they will have to jump on the venture treadmill at some point. A logical conclusion given that almost every major technology company founded over the past couple of decades has been venture backed. With that said, I frequently meet entrepreneurs that refer to the VC community with some level of derision. The complaints range from a view that VC’s don’t seem to take enough risk at the earliest stages to concerns around economic and strategic misalignment. While many of the anxieties I hear are certainly valid, a truly symbiotic entrepreneur-VC relationship can serve as an incredible accelerant for a business. For this to occur however, it’s important that entrepreneurs understand the VC business as much as VC’s understand theirs. Doing so will help determine both whether VC is an appropriate fit for your business, but will also provide the best opportunity of building a synergistic relationship with your investor. First, the truth of the matter is that very few startups are truly venture fundable. That’s not meant as an indictment. Many companies that never go on to raise venture money provide wildly successful educational and financial outcomes for their founders. They simply aren’t conducive to venture capital funding. To illustrate why, let’s dig a little deeper into venture math. Through advances in areas like cloud computing/hosting, companies today in 2015 can get off the ground at 1/100th of what it would have taken back in 1999. These cost efficiencies have created a world where ~10,000-20,000 companiesare formed every single year. Of these: -Approximately 1000 get venture funding -Approximately 50-100 encounter decent exits ($50MM+) -Perhaps 5-10 have bellwether exits (>$500MM). These 5-10 drive 90%+ of the returns within venture. Looking at this in another way, the power law of returns evidenced above makes the venture capital game really, really difficult. Every year, only about 10%-20% of funds provide risk-adjusted returns consistent with Limited Partner expectations. To take this to a more granular level, let’s do an exercise to examine a hypothetical $25MM Micro-VC fund with a fairly common expected return distribution model: *$2MM for fund admin costs, assuming no recycling The above example would...

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