(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 tell someone who is deciding between starting a new firm versus joining an established venture firm?

Ashmeet: There is no comparison. In one case you are an entrepreneur and in the other you are taking a job. Entrepreneurs aren’t told to be an entrepreneur – they choose for that path for themselves. It’s a difficult one, riddled with failure but also incredible rewarding. However, it only works if you choose it for the right reasons.

Gould: There are a large number of established firms in venture and some are 20, 30 and even 40 years-old. The most important aspect to seek out is quality. Sometimes it’s hidden, quality outweighs quantity in venture at any time.

What are some best practices around managing limited partner relationships?

Ashmeet: Communicate, communicate, and communicate! Good limited partners (LPs) expect open and complete transparency when it comes to the underlying portfolio, the firm, the environment in which it is operating, and what to expect from the firm in the future. Good communication with LPs is also not only about the numbers or facts. A well-thought-out perspective — and some “color” around the details — are critical.

With that in mind, what are some common — and avoidable — mistakes that new firms make?

Gould: Common mistakes are investing small amounts in too many marginal deals rather than developing a focus and having the patience to wait for strong opportunities. Another issue is whether to scale by adding more money, adding partners, or raising funds more often. All appear straightforward but are surprisingly hard to manage.

Building your micro VC in the right way, over time, takes a strong strategy. Keeping the above points in mind, growing your firm relies upon patience, great mentorship, and key differentiators. Bring these elements together and you’re joining the ranks of a burgeoning investment environment — one that entrepreneurs are turning to with great ideas and the promise of significant potential returns as well.


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