The Past, Present, and Future of Micro-VC
Although it’s been less than a year since I posted my primer on the Micro-VC market, there have been a lot of developments since then.
Loosely, Micro-VC firms are venture firms that raise funds that share the following characteristics:
< $100MM in size (although most are <$50MM in size)
>80% of initial checks are invested in seed rounds
Invest on behalf of 3rd party investors (LP’s)
Over the past 18 months, I’ve met with over 150 Micro-VC managers of all sizes, geographies, and investment themes. Before I attempt to prognosticate where I think the Micro-VC market is headed, I want to share some of my recent observations.
Growth, Growth, Growth
The table below, leveraging data from CB Insights along with SEC filings, displays the growth in the number of Micro-VC firms over the past five years.
-Of the 236 firms identified, approximately 50% have not raised a fund over $25MM. This number isn’t really shocking given the low barrier of entry at this size – the majority of these funds of this size are closed without any traditional institutional LP backing.
-Over half are located in Silicon Valley, with NY, LA, Boston accounting for just under a quarter.
Rising Bar for Institutional LP’s
As noted above, nearly half of Micro-VC firms have little to no institutional LP capital. Institutional capital for the Micro-VC Market includes Endowments, Foundations, Corporates, and Fund of Funds. With respect to Fund of Funds, many institutional Fund of Funds have been quite active over the past couple of years in Micro-VC, including firms like Venture Investment Associates, Cendana Capital, Sapphire Ventures, Weathergage Capital, Horsley Bridge, Northern Trust, SVB Capital, TrueBridge, Greenspring, Legacy Ventures, Next Play Capital, and Top Tier Capital to name a few.
Although many allocators are still exploring new Micro-VC managers, many have already placed their bets in the space, and the rise in numbers of new funds coming to market has made it virtually impossible to separate signal from noise.
Special Purpose Vehicles (SPV’s)
Due to capital constraints, Micro-VC funds often struggle to take advantage of valuable pro-rata rights in future rounds of their most promising portfolio companies. As a remedy, Micro-VC managers are now very actively forming SPV’s to enable pro-rata investing in top performing portfolio companies. Keep in mind that SPV’s don’t solve for fund level economics, but offer LP’s the ability to participate directly into portfolio companies at on reduced, albeit deal by deal economics.
Thus far, most have been done through offline channels, but we’re starting to see increased use of platforms such as AngelList (syndicates) for SPV’s.
Migration to investing later in the seed stack
As discussed my many this year, the seed-financing landscape has become clearly segmented along the following lines:
-Pre-seed ($500K-$1MM) – Good management team/market/solution, little traction.
-Seed ($1MM-$2MM) – Good management team/market/solution, early evidence of product-market fit and traction.
-Post-seed ($2MM-$4MM) – Same as above, but with fairly significant evidence of product-market fit and tangible business specific traction metrics.
Over the past year, many Micro-VC’s have continued to migrate toward seed and post-seed investing. This trend has resulted in a challenging supply/demand environment for pre-seed companies seeking institutional capital, and perhaps not as intuitive, has created a higher bar for follow-on financing for companies that have raised large post-seed rounds.
To expand, most lifecycle investors today juxtapose companies that have previously raised large post-seed rounds via a similar lens as companies that have previously raised small A rounds, and therefore grade to Series B level metrics.
With the prior two points in mind, many 1st generation Micro-VC’s have gradually grown fund and team sizes. Firms like Data Collective, Felicis Ventures, and SoftTech VC have fundamentally evolved into more conventional multi-stage investors that aim to drive value across all stages of development.
Internet and Mobile Dominate
Predictably, nearly 90% of capital invested by Micro-VC funds since 2011 has been deployed into the Mobile and Internet, with major sub-sectors as the following:
|1||Advertising, Sales & Marketing||Gaming|
|2||Business Intelligence, Analytics & Performance Management||Social|
|3||Marketplace||Advertising, Sales & Marketing|
|4||Apparel & Accessories||Customer Relationship Management|
|5||Education & Training||Education & Training|
Performance is strong
Take a minute to soak in the following #’s:
-In 2014, nearly 211 rounds of more than $40MM were completed
-In 2015 alone, nearly 50 US companies have raised rounds in excess of $100MM.
-Over the past 3 quarters, 51 companies have joined the “Unicorn” club.
These growth rounds have created substantial performance bumps in the portfolios of Micro-VC firms. Most Micro-VC firms raising capital today maintain very persuasive performance metrics for recent vintages.
I’m regularly seeing Vintage 2013 Micro-VC funds that have net IRR’s >25% and MoIC’s (multiple on invested capital) of 1.5-2.5x. While these largely unrealized numbers are compelling, they represent table stakes for managers hoping to raise in the current market.
Contrary to what some have posited, Unicorns (or more accurately, liquid unicorns), are essential for alpha returns – which is a 4X+ net return of capital. Here is a sampling of Micro-VC’s that have invested in >1 Unicorn. SV Angel leads the pack with 16, although important to note that their velocity based investment model provides for some skew.
Expansion, then Contraction
In addition to the presently 236 active Micro-VC firms, I’m currently tracking nearly 30 firms that are raising freshman funds. My expectation is that we’ll continue to see expansion with the number of active Micro-VC firms peaking around 350. From there, I anticipate a steady contraction of active Micro-VC firms, with no more than 150 in 2018.
A few factors will contribute to the contraction:
-Unstable LP bases – As mentioned, nearly 50% of funds are <$25MM. The majority of those funds have LP’s that are non-institutional in nature. If history serves a an accurate proxy, non-institutional LP’s, particularly small family offices and HNW individuals tend to be unpredictable follow on fund investors, particularly given the unlikely nature of significant distributions over the next few years, and the looming threat of a potential market contraction.
-Graduates – As covered above, several-branded Micro-VC’s have gradually transitioned to full stack venture firms.
-Many existing Micro-VC firms raising in 2017 and 2018, will be in the market for their Fund III’s. Outside of Fund I’s, Fund III’s tend to be very difficult as the fundraising dialogue emphasizes performance over promise
Private secondary sales
Very few Micro-VC firms today engage in secondary trading of shares in late stage expansion rounds. Several dynamics play into this including immature portfolios, difficulty in securing company agreement, along with the risk of sub-optimizing fund performance through premature sale. A few factors may act as a forcing function:
-Exits continue to get pushed due to the abundance of late stage capital.
-Pressure by LP’s on distributions prior to additional allocations
-Risk Mitigation – While firms could sacrifice upside by selling early, the specter of high flyers getting their wings clipped looms as a real risk. Amplifying risk are massive preference stacks, dangerous for Micro-VC’s if some of these companies end up liquidating for amounts equivalent or less than total capital raised. For GP’s and founders alike, I’d highly recommend Heidi Roizen’s blog post around the capital stack.
While the majority of first generation Micro-VC firms are seed stage generalists, the raw number of firms has highlighted the importance of demonstrating differentiation through domain expertise, network, or brand.
A few examples include:
-Maven Ventures – Consumer
-Lemnos Labs – Hardware
-Learn Capital – Education tech
-Govtech – Government technology startups
-Bullpen Capital – Post-seed round investing
-Precursor Capital – Pre-Seed stage investing
-Rivet Ventures – Investing in companies that focus on markets heavily influenced by female decision making
-Forerunner – Commerce focused businesses
-Luminari Capital – Media tech
-Ecosystem Integrity – Capital efficient Cleantech
Micro-VC firms are primarily structured as standard close ended, 2/20 structures. Even most SPV’s are done through offline channels. I’m expecting an exponential growth in the use of online platforms such as AngelList by institutional investors, both as a preferred avenue for SPV activity, but as a viable alternative to raising a traditional fund, particularly as data and network functionality emerge.
Drop in Accelerators
Over 200 accelerators exist globally today, and sell insight, community, and validation as value drivers. However, with the rise of co-working spaces and meet-up groups along with ubiquity of information, the notional value of pure accelerators has been declined, and best accelerators have become Micro-VC’s (500 Startups, YC, Lemnos Labs, MuckerLabs). I’m anticipating a huge drop in the number of pure accelerators in the next 24-36 months.
Thanks to CB Insights for the data and @Rohitkjain for culling through it.