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

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

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

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Is there ideal portfolio construction for seed funds?

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...

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

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

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

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Are LP’s still bullish on Micro-VC?

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

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Nano-VC funds are all the rage

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...

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So you want to start a VC firm?

Earlier this year, a few venture Limited Partners and I were comparing notes around the dramatic spike in seed VC (or Micro-VC as they often are referred to) firms we observed in 2014 and 2015. Below is a table illustrating the growth of the sub-sector. . The general consensus within the group was that the Micro-VC market was saturated and an expectation that we would start seeing definitive signs of consolidation of active Micro-VC firms at some point during 2016. As of today, that prognostication hasn’t exactly materialized. Today, nearly 340 Micro-VC firms exist in the US, with another 300+ currently in the market for their first funds (using Prequin data). Anecdotally speaking, I met 1–2 new fund managers nearly every week this year. The natural question that often (and appropriately) gets asked is whether this all is a good thing for the market or not. Like nearly anything in life, there are definitive pros and cons. Cons: -The number of firms and accompanying surplus seed capital inevitably creates valuation bloat at the seed stage, thus impacting indexed Micro-VC returns. For the record, I think this is overstated a bit as the seed stage valuation market is fairly efficient today, and in actuality, only a small % of Micro-VC firms are currently set up to lead/price rounds. -The low barriers of entry allow for touristy type of investors, who may not have the experience or skills to responsibly guide entrepreneurs through critical early decisions nor be can act as a good fiduciary for their Limited Partners. As history has shown, being a great entrepreneur or angel investor does not automatically equate to being a great institutional investor. -For Limited Partners, choosing where to allocate capital is similar to throwing darts blindfolded as the vast majority of managers feel and look the same. Pros: -Significant “smart” institutional capital for early stage entrepreneurs, something that became scarce when traditional VC’s went up-stream. –The acceleration of diversity that Micro-VC creates (lower barriers of entry are not always bad) -Niche focused managers that serve as real experts in extremely nuanced industries and sectors. –Help in fostering innovation to hubs outside of the major tech centers. This is true both within and outside the US. -Returns for the top performing Micro-VC’s significantly outpacing returns from top traditional funds (albeit with a different risk profile). With all that being said, we continue to firmly believe the Micro-VC boom to be a significant net-positive to the industry, regardless of how crowded or touristy it may feel now. While I don’t dispute the detracting comments, the pros far outweigh the cons by the mile in mind (I will however note that with regard...

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

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

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#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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