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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