Recently, I penned a few notes regarding recent exponential rise of “Micro-VC” (loosely defined as firms that raise sub-$50MM-$100MM funds to invest in seed stage companies). According to CB Insights, at least 135 firms such firms exist today!
Jeff Clavier, founder of SoftTech VC is without a doubt a pioneer in the institutional seed investing space. The SoftTech team has made over 150 investments since inception (including companies such as Mint, Fitbit, Wildfire, and Brightroll) and recently closed their 4th fund with $85MM in capital commitments.
Personally, I’m a big fan of Jeff and the SoftTech story and he was gracious enough to share with us his unique perspective on the ever-evolving seed stage financing market.
As a first generation “Micro-VC”, you have seen the evolution of the seed-stage market first hand over the last decade. Can you give us some background into your journey?
When I started full-time angel investing in 2004, things were certainly very different than they are now. Back then, seed rounds were smaller, and typically took many angels to fill up, most of whom were brought into deals based on whom they knew rather than the relevant experience and value they brought to companies. Party rounds, which I think are terrible, were certainly the standard.
Some full time angel investors like me became known as “Super Angels”. Some of the most successful investors within this group then began to raise formal venture vehicles and became the first generation of what we now call Micro-VC’s. It was actually a small group up until the last 2-3 years, when an influx of supply (new fund managers) and demand (from limited partners) created the current explosion we’re seeing within Micro-VC. Not surprisingly, I now often meet people who either want to be entrepreneurs or VCs, and sometimes both. The explosion of funding opportunities certainly provides entrepreneurs with more choices. In addition, the reduced barriers to entry have allowed some talented young investors start their own firms, many of which bring a fresh perspective to start-ups.
With the explosion of Micro-VC funds and the availability of other retail financing solutions, capital seems to have become a commodity, and not a particular scarce one. How has SoftTech become a desirable capital source for entrepreneurs?
Yes, capital is definitely a commodity at the seed stage. The best companies and entrepreneurs will have no problem raising given the number of seed investors, retail and institutional. Adding value through relevant connections, sector expertise, and operating experience is paramount today. We are fortunate to have become one of the established seed stage venture brands and our pitch is simple. We have demonstrated success in helping over 150 companies develop and scale over the past 10 years. Additionally, through our trusted relationships with traditional venture firms, we have been very successful in helping our companies raise Series A and B rounds from top tier firms. Our fund size also allows us to be a prominent follow-on player and an active partner much longer than most seed stage investors.
Of course, some seed firms will try to jump on opportunities and win by offering premium valuations, but that’s not going to be our approach, and usually not in the entrepreneur’s best interest. Instead, we are going to focus on being an active partner and adding as much value as we can. As such, we don’t typically invest in “party” rounds” as those result in a situation where no one cares enough to really help. Instead, we focus on leading or co-leading rounds, and forming the most strategic syndicates possible in our deals.
What are the things that you learned that you would relay to new Micro-VC fund managers that are raising right now, or thinking about starting their own funds? Is there anything that you would have done differently?
Well, first you must do an honest self-assessment of your skill-set and network. Raising money from investors is a huge responsibility. You should be able to give LP’s a reason to believe they will get a 4X return on their capital as a bare minimum. As such, every potential manager should determine whether they have the track record, skill-set, and network to be able to provide those type of returns. My first fund was really just my own capital, as I wanted to prove that I had what it took before taking on the responsibility of outside capital.
One mistake I made was not thinking carefully enough about my LP base. In 2007, my 2nd fund came together quickly and I didn’t really think through the composition of the LP’s that I was bringing in and whether they were going to be long term partners of SoftTech. As I found out, it does matter. When I was raising Fund III and keep in mind this was post-2008 when LP’s really pulled back, my core Fund II LP’s didn’t re-up despite great fund performance. This caused me to have numerous painful conversations with prospective new LP’s on why many of my old LP’s were not coming back in. I found out later that other firms who had carefully constructed a core LP base had a much easier time raising their funds during the same period. Therefore, I’d advise to be very thoughtful about your LP base. Build relationships with thought leaders in the space and make sure that they are committed to the long-term vision of the firm, and multiple funds. It’s no different than how entrepreneurs should think of their venture investors. Now we are fortunate position where our top 15 investors in our 4th fund, who we know are great long-term partners, comprise >80% of our capital base.
Finally, I’ll say that in today’s environment, you really need to be differentiated if you don’t have an existing brand. It could be geography, sector, or network, but you have to have a tangible point of differentiation and it has to be real.
We’ve seen the first generation “Micro-VC” funds grow in size – case in point is SoftTech, whose funds have increased steadily ($1MM,$15MM,$55MM,$85MM). Do you think the other successful firms will continue to raise larger funds to optimize around things like pro-rata rights?
It’s a good question. As I mentioned earlier, rounds for the best companies are getting bigger. As recently as six months ago, seed rounds were generally capped out at $2MM. Now, I am seeing $2.5MM-$3.0MM seed rounds; and I’m not referring to the edge-case YC companies, but the general universe of seed stage companies out there. Of course, more capital at higher valuations means raised expectations and bigger Series A rounds for the companies that have the necessary traction. For most well performing companies in our portfolio, I prefer them raise at least $8MM to $10M in their Series A rounds as I’m concerned that the performance thresholds that the companies have to reach to raise a series B are now higher than ever. The average series A round for our portfolio companies has been $10MM in the last year, but we have seen some of our companies raise much more! Going back to your question, it’s not just pro-rata, but it’s the fact that rounds for the very promising companies are getting larger and larger. While we are watching the market very closely, I am happy that we have a larger fund under us. I would suspect other top seed firms will also scale over time.
You’ve been very transparent on the companies you’ve missed on – LinkedIn, Airbnb, Dropcam, Uber, and Pinterest are all companies you’ve passed on. Are there any common themes that you could draw from the companies that you passed on?
In hindsight those do look like really bad decisions! Looking back, I passed because of various reasons, either I didn’t feel strongly enough about the business model, or they weren’t performing, or I just was just too busy at the time. I think big misses are always going to happen in the investing world, but I strongly believe that having a great team, like the one we have here at SoftTech strongly mitigates against that occurrence. There have been times that I may have not cared for a deal individually, but either Charles or Stephanie brings up something I might have completely overlooked or not considered. As a good investor, you have to keep an open mind and avoid “quick no’s”.
We recently did a stack ranking of all of our investments, from our breakout companies to our flameouts. We realized that 80% of the mistakes that we made as a result of overestimating the founder’s ability to execute and ignoring our intuition. If we do not 100% believe in the ability of the management team to build a company, then we are just passing. Like capital, ideas are commoditized. Also, having seen 20,000 companies over the years, I’ve learned that that you must always trust your intuition. If anyone on our team has their “spidey sense” triggered, it’s almost always a pass. I firmly believe that some of our mistakes might not have happened had we followed our spidey senses.