VCs win upon liquidity event. And that happens either via M&A or via going public. After that, the shares are transferred to the hands of the LPs and they choose how they’d like to liquidate or keep. To date, we have neither seen a trillion dollar acquisition nor a trillion dollar IPO. I’m not saying it’ll never happen. I’m sure it will, at some point. A combination of inflation and companies finding more liquidity when private markets are bullish.
As Charles Hudson suggests in his one of his latest posts, the venture world has been changing. What was once a cottage industry gave way to multi billion dollar funds. While there are still many small sub-$100M funds, LPs have started evaluating venture capital not as just one big industry, but segmenting it by size of fund. Small funds, sub-$100M. Medium-sized funds, $100-500M. And big funds, funds north of $500M assets under management (AUM for short). And as the Mike Maples dictum goes, your fund size is your strategy.
Returning a billion-dollar fund requires different kinds of investments and math for it to work compared to returning a $50M fund. And one day, as large funds continue to expand into multiple stages, check size, but also eventually into public markets, we might see them start to bet on trillion-dollar outcomes. Because to return a 11- or 12-figure fund, you need to do just that. But given the market we’re in now, I imagine that won’t be in the near future.
The 10,000-foot view
So the thing you have to gain conviction around, as a macroeconomist, is not how big a venture fund should be. Nor the debate on how many VC funds is too many. The number nor the size truly matter in the grand scheme of things.
For an illiquid asset class like venture, where you’re betting on the size of the home runs, not one’s batting average, what you have to gain conviction around is:
How many truly great companies are there every year
How much capital is needed to get these companies to billion dollar outcomes
For the latter, there are two main ways to get to billion dollar exits: going public or getting acquired. And while there are outliers, the best way is for these businesses to get to $100M of recurring revenue.
And everything else is downstream of that.
As an LP once told me, “In the 1990s, it took $7 million to get to first revenue. In the 2000s and into the early 2010s, it took $700K. Now it takes $70K.” With each era and each wave of technological development, founders become more capital efficient. There are less barriers to get to market. Now with AI, it might just be $7K to get to first revenue, if not sooner.
The question is how much capital is needed to get to $1M ARR. If we take a decent burn multiple of 1.5x, then we underwrite an assumption that it’ll take $1.5M to get to $1M ARR. And possibly $4.5M to get to $3M ARR. And somewhere in there, that founder will find product-market fit and turn on the growth engine. CAC (customer acquisition cost) falls. And lifetime value increases. Payback periods shorten. And if all goes well, founders may find themselves with a sub-one burn multiple. And after they hit $1M ARR, and they triple the first two years, double the next three, they’re at $100M ARR. Of course, I’m illustrating the above all in broad strokes. The best case scenario. But most things don’t go according to plan.
Then an investor has to figure out if one should only make net new investments or re-capitalize a select few of their existing investments.
Then as LPs, what is the minimum ownership percentages that can return funds at each differentiated stage and fund sizes? And due for possibly another blogpost altogether, how does a 7-8x multiple on forward-looking ARR impact round sizes and valuations across bull and bear markets?
All this admittedly is both art and science. But I will admit that larger fund sizes and playing the AUM game may not be the answer.
In closing
My friend recently sent me this letter that Sam Hinkie wrote when he retired as GM of the 76ers. In it, he quoted the great Sage of Omaha when he closed down Buffett Partnership. “I am not attuned to this environment, and I don’t want to spoil a decent record by trying to play a game I don’t understand just so I can go out a hero.” And it’s for that same reason, Sam stepped down. The same reason Jerry Seinfield turned down $110 million to do another season of Seinfeld. Even though the sequel business does quite well.
There is no shame in knowing when to hang up the cleats. And there is great power in being disciplined. In fact, it’s one of the most sought-after traits in fund managers. If not, the most sought-after.
In VC, it comes in all sizes, ranging from:
Fund size discipline. There a lot of GPs out there who have gone on to raise 9- to 10-figure early stage funds. A mathematical equation that becomes increasingly harder to prove true, given outputs need to reflect inputs. In other words, larger funds are harder to return. There are a lot of VCs who would rather play the AUM (assets under management) game than stay disciplined on returns. Not just paper returns, but real cold hard cash. In the words of my friend Chris Douvos, “moolah in da coolah.” To quote another line from Chris, “OPM (other people’s money) is like opium. It’s addicting.” Something one too many investors have gotten addicted to.
Thesis discipline. As a friend who’s been a VC across multiple economic cycles once told me, it’s much better to turn down an off-thesis hot deal led by a top tier firm than to take it.
Career discipline. To echo the words of Sam Hinkie above.
And of course, knowing that we underwrite billion dollar outcomes, rather than trillion dollar ones. Then again, that’s just a subset of fund size and portfolio construction.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Surprisingly, last week was the first week I’ve gone to multiple events for a given conference. Also I’m using the word “conference” very loosely here since I’m counting a tech week as one. What started off as ‘I’m going to support just one friend,’ ended up being a slippery slope, and supporting many friends, and catching up with friends in town. I mean, c’mon, how do you not at least say hi to a friend who’s flown from NYC or Miami? Perks of being bad at saying no.
That said, for the founder focused on getting to product-market fit, or actively fundraising, or the GP fundraising, your time is better spent elsewhere. But if you’re exploring and trying to increase the surface area for luck to stick, these events are great. So many fun, interesting ideas floating around.
Eight quick takeaways, before I go back and I let you go back to the rest of your week:
For VC/founder events, most attendees are founders. Smaller VCs went to the GP events. Bigger VCs just host their own.
For LP/GP events, most attendees are GPs. Went to an event of this type, and I kid you not, only met 2 LPs out of 15 people I chatted with. The rest were GPs. The folks you would like to show up at VC/founder events would rather pitch than to be pitched.
Interestingly enough, for the events that have a good proportion of LPs, most don’t seem to be investing in emerging managers. Anecdotally, have heard three of my friends who are individual LPs get turned down from LP events during SF Tech Week.
Smaller funds seem harder to raise than larger funds.
US large family office and institutional LP market is drying up. Most have overextended to buyouts and still need therapy for being burned in 2020 and 2021. For those that haven’t, they’re resorting to intros from friendlies.
Hosting your own events gives you better bang for your time than attending events.
And as one would suspect, AI dominates 70-80% of conversation.
Investing in unsexy industries is sexy. New moniker is to invest in industries where either 1/ people have scruffy beards or unkempt hair or 2/ meetings that require suit and tie.
Stay awesome, friends!
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
In 2016, I jumped into the VC world, knowing no better than what my forefathers and foremothers taught me. Outside of a handful few, many of the people I looked up to and sought for advice had been in the business for less than a decade. In effect, they started their investing career after the GFC (Global Financial Crisis) in 2008. While they still bore more scar tissue than I did, I learned quickly that the one question to ask founders early on was “What is your last round’s valuation?” or “What valuation are you seeking?” For the latter question, the implicit answer we sought out for was their 12-month revenue. And subsequently, their valuation multiple. In Mark Suster‘s words, we were “praying to the God of Valuation.” But really, their exit multiples matter more than the entry or current multiple.
For fund managers and partners, the question was “What is your IRR or TVPI?” or “What’s your AUM?”. Rather, the answer we should be seeking isn’t some function of their portfolio’s valuations, but the quality of the businesses they invest in.
To be fair, I failed to fully appreciate the latter answer until this year.
The odds aren’t bad, but that doesn’t mean they’re great
Jared Heyman wrote a great piece last year on the probability of success for YC startups. After parsing through the data, he found that after a couple years of survival, a startup is just as likely to go through an exit (i.e. acquisition or go public) as it is to fail (i.e. inactive). Additionally, ~88% of startups reach resolution (exit or inactive) around the 12-year mark.
It’s also interesting to note that the average time it takes for a YC company to exit (if they exit) is seven years. In fact, the time horizon has shortened in the past few years from an average timeline of nine years to five. Of course that’s pre-2022, so the time to exit is likely to increase once again to the mean or longer as:
Markets are less liquid. Valuations drop. Rounds are smaller. Buyers are less eager to buy. Founders have less access to liquidity and exit opportunities. As such, the markets will demand more proof from founders of market traction.
Investor sentiment is guarded, echoing Howard Marks. I haven’t seen the newest numbers but at best, I imagine we’ll see more capital go towards existing investments, maintaining overall investment volume. At worst, a decline of capital deployment, outside of ephemerally “hot” industries, like generative AI.
Investors’ key worry is investment losses. Investors up and downstream become more risk averse.
Interest rates are rising to curb inflation, leading to a debt investor’s market rather than an equity investor’s. Founders are likely to turn to expensive debt instruments (and many already have). Higher interest rates also mean greater return expectations from investors.
Jared does note in another piece that “while YC startups may cost 2-3 times as much as their non-YC peers to investors, they’re worth 6-7 times as much in terms of expected investor returns.” It’s great to be an LP in YC, but tough to be choosing YC startups. Of course, at the very end there’s a gentle reminder that VCs (and angels) are defined by the magnitude of their successes rather than the number of their failures (and successes). Just because a portco gets to an exit doesn’t mean it’ll be a fund returner. With shifting markets, this will be as true for YC under Garry’s leadership as for any other fund.
Of course, I don’t mean to pick on YC. They do a tremendous job of picking founders. And it’s true that they have set the golden standard for startup accelerators. It’s just that the above data was easily accessible.
Portfolio consistency
Interestingly enough, Oliver Jung, Airbnb’s former VP International, wrote half a month later that Adinvest’s Fund II made him $200 on every dollar he invested in the fund, largely because of a 1000x Adinvest II made into Adyen.
That’s a phenomenal outcome! To make investors back $200 on every dollar invested is definitely one for the books. The question becomes (and I have no inside scoop on this): How did the rest of the portfolio do? Was Adinvest’s Fund II purely based on luck or is there a consistent model that can be replicated in future funds?
For that question, it begs another. If we took out Adinvest’s investment in Adyen, what is the DPI (distributions to paid-in capital) of the rest of the fund? That will dictate Adinvest’s ability to raise a subsequent fund, at least from the larger, more sophisticated LPs. A great and consistent portfolio may look something a little like this.
Given that the average fund’s returns (with a large enough portfolio i.e. 100 portcos) normalizes to a 3x gross return — venture’s Mendoza line, 3-5x would put you in the ball park of good. High single digits would put you in the great category. And double digits would put you in epic.
And if Adyen really was the sole outlier success, did the GPs have the conviction to double down in subsequent rounds? If so, how did they earn their pro rata?
Sometimes all you need is one investment to push you from a nobody to a somebody, but if you’re intent on building a multi-decade-long career in the space, your founders should see you in the same or better light than those equipped with asymmetric information (i.e. those who read about you in the media).
While many Fund I’s and II’s may not have a reserve ratio, were the GPs and LPs able to continue to invest via SPVs? By doubling down, it’s the difference between a strategy to win and a strategy not to lose. How much of Adinvest’s AUM does their investment in Adyen account for? And being a fund manager means balancing oneself on the tightrope between the two strategies. In doubling down, that investment becomes a larger percent of the capital you manage (AUM). If you lose, you lose much more. If you win, you win a lot more.
Of course, this is true for any fund. I ended up overly picking on the case study of Adinvest to illustrate the point, but I have nothing against the great success Oliver, the other LPs and the team at Adinvest did have. On a broader spectrum, the purpose of having many shots on goal is theoretically so that you will have a few outliers. So your fund can grow based on a consistent strategy.
There are many times when all you have is that one outlier (often still in paper returns, not distributions yet). It happens. I’ve seen it happen. But if that one doesn’t work out, how forthcoming are you with your “disappearing TVPI?” I imagine a lot of investors who are planning to raise in 2023 will come face to face with these questions, having made big bets on hot startups in the last two years. Will you shrug it off? Or will you candidly share the lessons in which you learned?
The above is just something I’ve thought about a lot more as I see more emerging GP fundraising decks, as they boast about their angel portfolio (if they did have one).
In closing
There’s a proverb that goes: A broken clock is still right twice a day. You can be the worst investor out there, but with enough swings at bat, you’ll still be able to hit some outliers.
In the world of investing, you’re guaranteed to be wrong more often than you’re right. But I’ve seen many that do a lot of stuff ‘wrong’ and still have a winning fund. The big question… and the question, sophisticated and institutional LPs are asking is: Is it repeatable?
So, even if you did hit some home runs, is your success repeatable?
One last footnote. In talking with a number of investors who’ve been in the business for more than a decade, I’m starting to realize that selling (i.e. knowing when to sell and how much to sell) is just as important. An art and a science. I’ve written about it before (here and here), but I imagine I’ll revisit the topic again in long form soon. Especially as I see more discourse on the topic and funds close and liquidate in the near future. From great ones like Union Square Ventures to those who need to return some DPI to raise their next fund.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
Any views expressed on this blog are mine and mine alone. They are not a representation of values held by On Deck, DECODE, or any other entity I am or have been associated with. They are for informational and entertainment purposes only. None of this is legal, investment, business, or tax advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
Last Friday, one of the greatest operators and super-connectors I know, who also moonlights as an angel investor, asked me: How do I know if I should professionalize as an investor?
Undeniably, a great question. But before I share my answer to her question, I thought it’d be best if I first elaborated on what “professionalize” means in this context. It’s a term we have used more than once here at On Deck Angels. And as a result, it has spilled over into the vocabulary I use even outside of venture. But in the context of investing, professionalize is where one would go from an amateur, part-time investor to a full-time investor. Either working at a fund, starting their own syndicate or fund, or as a full-time angel.
The thing is, to be a career startup investor, you have to be lucky. The capital required to have a seat at the poker table is high. While there are many platforms — from Republic to Wefunder to Titan Invest — that are working to democratize access, the truth, for now, still is that to access the best deals, you’re either lucky as a network leader or as a capital allocator. In other words, do you know the best and most entrepreneurial talent? And do you have a frick-ton of money?
And given that some element of luck on top of skill is table stakes, I felt the best response I could give wasn’t in the form of a statement or opinion, but in the form of five questions.
Why do you invest? What compels you to continue investing?
What are two positive adjectives you would use to describe your sibling*? What are two negative adjectives you would use to describe your sibling*?
*Or life partner, or someone you know really really well.
Have you ever laid someone off and regretted it? Why did you regret it? And at point after the event did you notice your regret?
If not… as an investor, have you ever said no to a founder and regretted it? Why did you regret it? And at point after the event did you notice your regret?
Of the five people you hang out with most, what are common traits that at least two of them have? List as many as you can.
If you were to start a fund or syndicate tomorrow, what would you call it?
So before you keep reading, I would recommend pausing. And to pull out a notepad and jot your own answers down to the questions above. It’s a useful exercise I ask myself, and evidently others as well, if you’re looking to professionalize as an investor.
When you’re ready, keep reading beyond the below image, as I’ll share my rationale behind the above questions.
*Author’s Note: Effectively, I was trying to space out the questions from the rationale of why I ask them below as much as I could, so that the below text wouldn’t influence your thinking (if you plan on doing this exercise).
Motivation – Why are you an investor? The underlying motivation matters. Are you in it for money? To pay it forward? To prove someone or some notion wrong? How fleeting is your motivation? Raising a fund is a decade-long relationship. Raising three is two-decades long of a relationship. So, the question is how deep is your motivation. Can it last multiple decades?
Strengths/weaknesses – This question is adapted from Doug Leone’s. People often describe others in comparison to themselves. For example, if I say Joanna is funny, by transitive property, I believe Joanna is funnier than I am. If I say Kai is smart, I believe Kai is smarter than I am. I often find this question to be much more useful in understanding a person than just asking for their strengths and weaknesses. After all, adjectives are, by definition, comparative words.
Standards – This question is a riff on Matt Mochary’s. If your answer to the question is no, then you don’t know your bar for excellence. Why does your bar matter? There’s a saying that A-players hire other A-players because they know just much it takes to win. B-players, on the other hand, know they’re not as good as A-players, but on average, still want to feel superior, so they hire C-players. A-players can stand B-players, but can’t stand C-players. So eventually, the A-players leave your company. Why does this matter for an investor? You need to be able to differentiate between an A-player and a B-player. The difference between a great founder and a good founder is a fine line, and most people miss it. If you want to have a chance at being a top decile investor, you need to know. After all, people often learn more from loss than from gain. For the second part of the question, being a great investor — or to be fair, a great anything — is all about the velocity in which you learn. Speed and direction.
Deal flow – This question is a proxy of where you’re going to the majority of your early deal flow, and likely who and where you’re connected the most with. The follow up would be do you get enough quality deal flow from people with these traits. In other words, if you had the capital, are you confident you could put at least $250K to use every quarter? If not, stay a scout or raise a syndicate instead of a fund. Until you can build up to this.
Legacy – Building a fund is multi-generational. Just three funds would be a 20-year relationship. And the best funds often outlive the founder(s) themselves. So the biggest question here is what kind of legacy are you trying to build? Or are you trying to build one? This legacy, founded upon your values, determines how you plan for succession and who you raise to be your firm’s next leaders.
In closing
Of course, the five questions aren’t an end-all-be-all. There’s still the ability to think through fund strategy and portfolio construction. There’s fund admin. The back office. Tech stack. Picking strategic markets where you have an unfair advantage. That said, if you can answer the above questions well, you’ll have a compelling narrative to either fundraise from LPs or join a larger fund.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
Any views expressed on this blog are mine and mine alone. They are not a representation of values held by On Deck, DECODE, or any other entity I am or have been associated with. They are for informational and entertainment purposes only. None of this is legal, investment, business, or tax advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
The past 2 weeks brought me a whirlwind of conversations with emerging managers and LPs, catalyzed by the emerging LP playbook. And of the former, I’ve come across two main themes:
Everyone — I kid you not… everyone — has top-tier VCs as their follow-on and/or their co-investors. What was once upon unique is no longer so.
Eric was right. There’s an overabundance of the word “signal” in venture wonderland these days — to the point the word itself has lost its meaning. By definition, it should mean that is unique and stands above a sea of noise. For many investors, that means either investing in brand-name startups (i.e. SpaceX, Figma, etc.) or investing alongside brand-name investors. The latter, unfortunately, is also a product of the ecosystem as many LPs seek social proof about your investment thesis from others’ who have a proven track record. The former gets a bit sticky. A lot of these logos are either off-fund-thesis or came as a Series B syndicate investment (but the fund itself is investing in pre-seed or seed).
After publishing the emerging LP playbook last week, I've been lucky to chat with quite a few emerging managers raising their Fund I's
And there are 2 common themes I see in their decks:
1. Tier 1 VCs as follow on investors are table stakes 2. There's a lot of logo shopping
To piggyback on the above, the notion of signal is worth elaborating on, likely a vestigial appendage of the past two years.
Let me preface by saying that it takes a lot to get to conviction.
In 2020 and 2021, many investors’ calculus of startup signal boiled down to three things: great investors, great traction, and great team. And in that order. That is first and foremost what I see a lot of professionalizing investors do. I can’t entirely blame them since the ecosystem itself propagates the belief that if a Tier 1 VC jumps in, you’re more likely to get to a great exit. Or at the minimum, get a great mark-up to make your IRRs and TVPIs look better. On paper, of course.
But what I believe a lot of investors are missing is that… venture is a game that’s not about your batting average, but about the magnitude of the home runs you hit. You’ve heard it before, and you’ll continue to hear more of it. Unlike other financial services, VC is driven by the power law. 80% of your returns will be driven by 20% of your bets. That’s the 10,000 foot view. Let’s be honest. Most of us, myself included, don’t take that panoramic view every day or even every week. In fact, I see many emerging managers only take that view when they’re forced to. In other words, when they’re in fundraising mode.
For many professionalizing angels and syndicate leads, that becomes trying to string a narrative from seemingly disparate data points. Or at least, it seems that way.
As Asher Siddiqui told me, “[after] you look at their whole life and career history, and look at their thesis, if the thesis doesn’t make complete and perfect sense, then I don’t think this is a ‘great‘ fund manager. If it fits like a glove, then yes, they could be.”
The best GPs are disciplined even before they start fundraising. They focus on the thesis they want to raise on when they do. That’s not to say they don’t invest off-thesis every so often. But they don’t pitch their off-thesis angel or syndicate investments as part of their thesis-driven track record. But I digress.
In chasing signal for the sake of signal, when you hear of a hot deal every other day, many investors forget to be that belief capital for founders. I’m not saying that an investor should do so for every founder out there. But to pick a few, or even just one. One that they’re willing to take the swing before others do.
The signal is their own conviction in the founder.
The first half
Because of this progression, there’s been a new two-part question I really enjoy asking emerging GPs. The first half:
Which company in your portfolio you think is still underestimated?
Which company in your portfolio didn’t get the investor attention you expected but are still extremely bullish on their growth? And why do you still believe in them? What are other investors missing out on?
It’s not about track record or social proof here. It’s about the ability to recognize exceptional talent and articulate it clearly. Hopefully, a rose growing in concrete.
Well, in terms of the odds, you’re likely to be wrong. But that’s okay. You need to be willing to be wrong to achieve outlier success.
Fund I is often the proof-of-concept fund for the emerging managers I’ve talked to. They start by writing small checks, don’t lead rounds, and don’t fight for ownership targets. They claim to be extremely helpful and hands on. Then again, expectation often differs from reality, especially if they’ve never been so before (where LPs discover through reference checks). And because they’re writing smaller checks now, I’ve seen many implicitly hold off on developing a framework to get to conviction until Fund III. Whereas the best GPs start thinking about it early on.
You can think about it this way. As long as you’re benchmarking on signal via other investors, why should an LP back your thesis when they can back your “signal”?
For individuals and smaller family offices, they’ll still back you. What they’re buying is access, since they can’t afford nor have the relationship to be an LP in the “signals.” Larger LPs have the optionality to do so. And if you’re an emerging GP hoping to grow as a professional manager by having larger and larger funds, you eventually need to raise from large LPs. At least, until the SEC changes their 99 limit. And to do so, from larger LPs, means you need to bet where their existing portfolio has not bet before. Plus do it well.
The second half
If you haven’t already, a great way to build a referenceable track record is to sweat the details. Yes. The details matter. Nate Silver, one of the best poker players of our generation, said earlier this year, “you can’t just get the big things right in poker. You have to get the small things right too. It’s too competitive of a field right now.”
Though he said venture is different, I believe he’s half right. Most investors don’t sweat the small things. But investors should. Today, that’s how you stand out.
It might not have been true a decade ago, but now it is. Just last year, in 2021, there were 730 funds created. To put that number into perspective, on average, that literally means two firms closed every single day last year, including the holidays and weekends!
Capital has become a commodity. In 2021, speed was a differentiator. Clearly, in 2022, it is not. Today, it’s tough being a founder. If you’ve raised in the last two years, you’re considering extending your runway. That means having tough conversations to reduce your workforce, your benefits, or your salaries. If you haven’t raised, it’s a hard market to be raising in now. And so the differentiator today, is in two parts:
Helping founders navigate these tough situations. In other words, being (proactively) helpful.
And helping founders raise their next round. Mac Conwell recently shared a great thread on how powerful a founders’ network is to get funding. The same applies to an investors’ ability to help their portfolio raise capital. How liquid is your network? It’s not about who you know, but how well you know your friends downstream, and how can you get them over the activation energy to invest. Don’t get me wrong. There still needs to be a certain level of hustle from the founders themselves. But a great investor often steps in to reduce as much friction as we can in that process.
Both of which have long been the job description of being a VC. It’s in the small things. Jump on a 2AM call. Help your founders figure out the wording for a reduction-in-force. Fix the sales copy to better close leads.
There are 10-15 character-building moments in a founder’s journey where the moat they build around the business (as opposed to just the product) is not IP or early product traction, but rather from the lessons obtained from scar tissue.
It’s hard to predict looking through the windshield when these moments are, but quite obvious via the rearview mirror. And the best an investor can do is be there as much as he/she can. Albeit hard to do for every company in your portfolio, and that’s the truth. The wealth of information creates a poverty of attention. The larger your portfolio, the harder it is to be truly helpful to every single one. So focus on founders who need you, rather than those who will do great without you. Reputation is built in wartime and realized in peacetime.
So, the second part to the above question is:
What did you do for this company that no other investor or advisor did?
… where I’m looking for answers on how this investor went above the call of duty to help a company they believed in grow.
In closing
In summary,
Which company in your portfolio you think is still underestimated?
What did you do for this company that no other investor or advisor did?
This is by no means original, but heavily inspired by the recent conversations I’ve had, as well as helps me build my own framework for analysis. In parts, this question is a derivation to the check size to helpfulness ratio (CS:H). How helpful are you as an investor? When you say you’re founder-friendly, do you mean it?
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
Any views expressed on this blog are mine and mine alone. They are not a representation of values held by On Deck, DECODE, or any other entity I am or have been associated with. They are for informational and entertainment purposes only. None of this is legal, investment, business, or tax advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
Before we dive into this blogpost, I’ve been asked by my legal friends to include the below disclaimer. I have a version of this at the bottom of every blogpost, but nevertheless, it doesn’t hurt to reiterate it again.
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Back in the hallowed halls of my elementary school, I had a principal whose presence was always larger than life. He was often the optimist and, with words alone, could figuratively turn water into wine, and any mistake into an opportunity. Ironically, there was a sign that hung above the door to his office that read: Opportunity is nowhere. An odd sign that seemed to be the Hyde to his Jekyll.
I spent a whole year contemplating why. And on the last day of third grade, I finally mustered the courage to ask him.
“Mr. M, why do you have that sign above your door?”
“What sign?”
“The sign that says ‘Opportunity is nowhere.'”
He paused and chuckled, “David, it looks like I bought the wrong sign. It’s supposed to say ‘Opportunity is now here.’ But now that you mention it, you could say the only difference between no opportunities and endless opportunities is just one small space.”
In the venture market, that small space blossomed in late 2020. In a flurry of SPACs, secondary markets, and tech IPOs, exit opportunities for venture-backed companies were flourishing. There were multiple paths to liquidity. Tech employees saw their net worth grow, and more accredited investors were minted by the day. Alumni syndicates grew in membership and deal volume.
With a surplus of capital in the market, the money had to go somewhere. Not to savings accounts. But to goods and services. Crypto and NFTs. Startups. And other capital allocators.
Adjacently, the COVID days saw the (re)emergence of new markets. Ecommerce. Fintech. Remote work. Future of work. Web3 and the metaverse. Just to name a few.
In 2021, VC fundraising activity surpassed $100B in funds raised for the first time. $128.3 billion across 730 funds, to be exact. Carta also saw a massive jump in the number of Fund I’s created last year. More than ever before, there was an abundance in opportunities to invest in venture funds.
Anecdotally, in my work at On Deck Angels and at DECODE, I’ve seen a rise in the number of opportunities to invest into funds as well. Via various other platforms as well:
Revere — where you can discover and evaluate venture fund managers through a unique rating framework. They’ve also recently launched explorevc.com for those curious about who’s in their pipeline;
Allocate — an end-to-end platform that covers everything from discovery to capital calls and keeping track of your portfolio;
Arlan Hamilton famously raised $5M of her fund via Republic, an equity crowdfunding platform. More recently, Cathie Wood announced the opportunity for non-accredited investors to invest in the ARK Venture Fund through Titan.
There was and still is a wealth of noise, but a poverty of “signal” — a word that may have lost its true meaning in these past few years. When signal is everywhere, it is nowhere. So more than ever before, more than opportunities, what the world needs more of are frameworks. Frameworks on how to differentiate for yourself signal from noise.
There is a wealth of content and discourse in the broader world for investors, which include advice on personal finance, investing in stocks, option trading, and of course, quite a bit, in the world of startup investing. But surprisingly little in the realm of investing in venture funds. The only ones I could find were OpenLP and SuperLP, which if you know me I had to ask both of their authors for their latest insights here as well.
As we were wrapping up our conversation on a sweltering late summer day, Martin Tobias, founding partner at Incisive Ventures, told me:
“Somebody should write a book like Jason Calacanis’ Angels, but for LPs.”
And he’s completely right. While that is a larger endeavor altogether, hopefully, this blogpost serves as a preamble for a greater conversation.
Who is the emerging LP?
An LP, or a limited partner, in the context of this essay, is someone who invests indirectly, rather than directly into startups. While investors in syndicates and SPVs are also counted as LPs, for the purpose of this piece, I’ll focus on people who invest in funds.
If you’re an emerging LP, you’re most likely writing checks into Fund I’s. Maybe Fund II’s, if you’re lucky, can write larger checks ($250-500K+), you have something a GP wants, or some permutation of the above.
Effectively, this blogpost is dedicated to the investor looking to invest in fund managers who have yet to prove their institutional track record. And just like investing into a pre-seed founder, searching for product-market fit, the checks you are writing are… belief capital.
If it’s belief capital, assuming the GP has the underlying mechanics down (portfolio construction, fund strategy, etc.), it’s all about people. And if it’s all about people (I’m overgeneralizing), how you win as an LP is determined by your ability to differentiate the top decile from the top quartile. Part of that requires some level of intuition. But I am ill-equipped to speak on LP intuition, as opposed to VC intuition. So, I had to ask folks with more miles on their odometer.
Asher Siddiqui shared it best in our conversation from the perspective of an emerging fund manager:
“Here’s the problem that I have. Imagine you’re an emerging fund manager and you think you’re hot shit. How long do you think it takes before you figure out if you are?
“The average deployment period is 2-3 years. You launch Fund I in Year 1 and launch Fund II between Year 2 and 3. You close the second fund around Year 4. By Year 7-8, you now have some DPI from Fund I, early DPI from Fund II, and are now writing your first checks from Fund III.
“The truth is no one knows if you’re a great fund manager until you’re eight to ten years in. That means if you’re meeting a great manager, you’re meeting them when they’re already at Fund III, or when they’re raising Fund IV.”
Similarly, the truth is as an emerging LP, you probably don’t have the opportunity to invest in “hot shit.” Why?
Top-tier funds are oversubscribed, and have a waitlist to even get the chance to invest.
And if you could, due to the size of their funds, you need to be able to write checks on the magnitude of 7-figures and up.
Rather the buffet you have before you is the opportunity to support the best before they’re the best. So instead of looking for lagging indicators, like TVPI, DPI, and IRR, the conversations that sparked this blogpost is intended to look for leading, predictive indicators. But as you might guess, there is no one right answer in foresight. But I do hope the below serve as tools in your toolkit as you grow your arsenal of frameworks for investing in GPs.
As a quick note, wanted to share some quick definitions I wish I knew at one point in my life:
TVPI: Total-value-to-paid-in capital, aka paper returns
DPI: Distributions-to-paid-in capital, aka the actual money you get back, or Chris Douvos calls it: “the moolah in the coolah”
IRR: Internal rate of return, aka how fast your money appreciates per year
Net IRR: your IRR after fees, carry, expenses are accounted for, and what LPs care about more than gross IRR
GP: General partner of a VC firm, aka the head honcho at a firm
Finding the best LPs
The world of fund investing is, for lack of better words, opaque. There’s no public Rolodex of limited partners. If you stick around the venture world long enough, there are familiar names that regularly pop up in fund pitch decks or during VC happy hour. And outside of the big institutions who write $5M+ checks that you might find on ad hoc expeditions into the world of the internet, the two best places I’ve found so far for information on LPs is Sapphire Partners’ OpenLP.com. And scouring AngelList’s syndicates and PCN (Private Capital Network) for their LP networks, neither of which are public either.
At the same time, most individual LPs don’t go “shopping” for deals. They invest opportunistically into people they know and trust or alongside people they trust. In a way, this blogpost is also designed to help the individual LPs below shop for deals. By sharing the fact they LP publicly, my sell to them was that maybe this blogpost will the earliest semblances of fund deal flow to them.
Just as a fund manager brings smaller LPs on for very specific reasons, an LP should have a similar rationale to why they are investing in a GP. It’s a two-way street.
Methodology and a table of contents
I’m going to preface by saying: This isn’t an academic research paper. So as such, I may not have followed all the best practices in doing academic research. Nevertheless, I promise you won’t be disappointed. The below found its genesis scratching a personal itch that grew into:
How can I best support emerging GPs?
A first step into demystifying the black box of LP investing
Help individual LPs build thought leadership and discoverability, aka deal flow
And, building an investing playbook for pre-product-market fit funds
To each individual, I asked just four questions:
Apart from TVPI and IRR, what are leading indicators that differentiate the great GPs from the good GPs? In other words, the top decile from the top quartile?
In fairness, I iterated on the wording of this question the most because a few LPs I asked early on only had one answer: track record. And track record — in other words, TVPI and IRR, especially DPI, are lagging indicators.
Any red flags about emerging GPs that new LPs should be aware of?
What common pieces of advice should emerging LPs ignore, if any?
This was one that either completely hit or completely missed. The latter due to the fact, that there isn’t much advice, period, that is shared between LPs who don’t already know each other. One of the main reasons I believe this blogpost should exist.
Anything else you think first-time LPs should be aware of?
Some shared over text. Others over email. And a handful of others across calls and coffee.
As such, I’ve segmented this blogpost into five main sections:
In the words of my friend and colleague Gautam, “A big part of direct early-stage investing is more than just financial return. The same holds true as an LP, especially as an emerging LP. Be very clear about why you’re an LP. An investor who invested in the same fund as I did called his LP commitment the most expensive newsletter subscription he’s ever been a part of.”
Why you should be an LP
“The most important question to answer is why do you want to be an LP? To me, there are three reasons:
You want to build a career in this space – potentially a fund of funds, or manage someone’s family office.
You’re not the best at picking individually good startup deals to invest in, and you want to be strategic. For example, if David has the best deal flow in web3*, and I don’t, I want to invest in David.
This manager also has access to top deals – top deals that would otherwise be impossible for you to get into. If you invest in the fund, you also get access to the fund’s pro rata rights.”
— Shiva Singh Sangwan, 1947 Rise *Author’s Note: I don’t have the best deal flow in web3, but am flattered to be the example.
“I’m also a startup investor myself. My goal is still to uncover the best investments out there. So, there are 5 reasons as to why I invest in funds:
Investing in outliers: I invest in funds who have access to opportunities I may have missed myself. I don’t want to miss the next Gong.
Knowledge and network expansion: I want to expand my knowledge and network of what and who is out there. To become a better fund manager and uncover what’s happening out there in the market, I read other GP’s investor updates. I learn from what they learn.
Expanding my deal flow: I invest in others’ funds to get to invest in the companies they’ve invested in, and earning my right to, by being as valuable as an LP as possible.
Learning: I’m able to learn about areas that I’m very interested in. For example, I’ve spend the past year trying to learn more about web3, so I invested in web3 funds. I read the GPs’ investor updates and have effectively built a braintrust of GPs who are experts in web3.
Regional coverage: I LP into funds in emerging markets, namely, India, Southeast Asia, and Europe. I want to back someone who’s just starting with a Fund I, in a region I don’t have coverage on.”
— Sriram Krishnan, Kearny Jackson
Why you should NOT be an LP
“Venture isn’t a winning strategy for retail investors. Many investors cite that new funds outperform the S&P 500 or Russell 2000, but the truth is most venture funds have a low probability of beating the NASDAQ. Those that say otherwise are ignorant. Venture, as an asset class, is worse than the best public market alternative ($QQQ) unless you are getting the best outcomes. You need to be in the quartile, by looking for the top decile. Only then can you beat the public markets.
“If you don’t fully understand what that game is – one you’re not going to get your capital back for 10-12 years, then stick to public markets and small checks angel investing to satisfy startup investing curiosity. People are often insular to what they see and believe, especially on Twitter. Everyone is talking their own book. Do your homework.”
— @Cashflow_Cowboy
“Adjust expectations. People think that they’re going to always make 10x on their money, but I’m reminded of a story from early in my career.
“In the aftermath of the dotcom bubble, a time during which a looooottt of people made a lot of money, a big endowment that had one of the top venture portfolios looked at their relationships in their totality and found that only three of their managers exceeded a TVPI of greater than 2.5x for the whole of their relationship (across all the funds). And if you look at VC as a whole, returns have only very rarely met the lofty expectations that most people have. We’re looking back at an extraordinary time, but I think that when people look back, especially at a landscape littered with dilettante funds, that we’ll say that as the TVPI matured into DPI (the ‘moolah in da coolah’) times were pretty good, maybe even great, but not all the trees grew to the sky like some thought they would.”
— Chris Douvos, Ahoy Capital
“My biggest piece of advice for this audience is to actually not invest in venture. Most of the entrepreneurial network over-indexes investments to venture capital or start-ups. But our career is probably already over-indexed to this high risk asset class. I encourage entrepreneurs who start to invest to look at real estate, stocks, private equity, or private debt/BDCs. You can actually buy private debt on the public markets, called BDCs – business development corporations – that are loans out of companies and pay 10-15% yield. Or mid-market private equity generates ~20% IRR’s with far higher confidence than a venture fund. Asset allocation across these different profiles are key.”
— Vijen Patel, 81 Collection
What Makes a Phenomenal GP (As Opposed to just a Good One)
For the purpose of this section, I’m going to depart from the usual metrics – like a 3x net multiple, or a 25%+ IRR for funds longer than 5 years. Why? Since (a) if those metrics exist, these funds are no longer non-obvious, and the likelihood of you having access to these funds as an emerging LP is slim (and fund performance speaks for itself), or (b) if they don’t exist, you’re going to rely on qualitative measures — just as you would investing in most early-stage startups pre-PMF.
Consistent, clear, and preemptive communication
“Most managers are not that great when it comes to transparency around fund operations. Things like: What are your latest investments? What’s the thesis behind some of those investments? How are they performing over time?
“Some of these things get answered, if I’m lucky, on a quarterly basis, but often on an annual basis or less. So if you find a team that’s consistent about sharing progress on a monthly or at the very least on a quarterly basis and are really responsive to answering your emails and any phone calls, that’s a good sign behind a team that’s working very hard to serve the interest of its LPs and treating the job like a fiduciary.
“I’ll put a little bit of side note here. This kind of behavior is great with founders, too. When founders are really great about communications, it correlates very well to their performance over time.”
— Eric Bahn, Hustle Fund
“The six funds that I’ve invested in so far (listed here if that’s helpful) have all been communicative, stayed true to their thesis, and given me opportunities to learn and help to the extent that I had hoped for.”
— Rebekah Bastian, OwnTrail
“Sometimes things don’t perfectly line up — a GP might discover new opportunities or areas of interest as they start investing in a fund. Or increased competition. If strategy changes have occurred, ideally the GP would have been flagging this to their LPs over the course of the two years but for a new prospective LP being able to speak to the changes is important.”
— Beezer Clarkson, Sapphire Partners
The best have a unique perspective
“As an LP who also invests directly into startups, we seek GPs who have something unique – some kind of insight. It’s not always about having the highest net return. These days, there’s not enough GPs who have a unique angle on the market. It could be how they diligence deals, how they set their investment strategy, or what top investments look like.”
— Anonymous LP, $30B AUM Fund
“The funds we have known that are top decile have a point of view, this can be expressed as being thesis driven, but doesn’t have to be. It does though provide a reason for why they invest in what they do and why an entrepreneur picks them.
“They have also, in our experience, have had multiple fund returners within one fund. Not always, if an exit is large enough with respect to the size of the fund, it is possible to have a top decile fund with just one fund returner. The power law is alive and well in the top decile funds we’ve seen. This means swinging for the fences with respect to a fund’s investments as well as supporting this with a portfolio allocation and management strategy that enables a significant exit to provide for strong returns.”
— Beezer Clarkson, Sapphire Partners
“Every investor claims to have a value. There are very few cases where investors pitch otherwise. Sector specific funds may have a real value add for very early stage startups.
Uniqueness is not about investing into a vertical or type of technology, but about their ability to measure the size of an idea. Great managers know how to identify big ideas that others aren’t seeing. Even more true if you run a big fund; you must be investing in even bigger outcomes.”
— Itay Rotem, EdRITECH
Is this strategy repeatable?
“Differentiating between ‘top decile’ and ‘top quartile’ is really just going to be luck, for the most part. If you’re simply measuring and assessing ‘good GPs’ from the great ones, by track record, here would be my top few:
“What % of the portfolio comes from the top 1, 2 or 3? If you can deliver a top-quartile return WITHOUT your one winner / ‘lucky bet’, that’s really good.
What % of companies successfully got funded from investment to the next round?
Seed —> Series A should be >35%
Series A —> Series B should be >50%
Series B —> Series C should be >50%
Series C —> Series D+ should be >60%”
— Aman Verjee, Practical VC
“For GPs with young track records, we look at what the contributing companies are. Who are the fund returners? And can they replicate the same strategy? When diligencing GPs, we also talk to the founders they invest in. Essentially, whether there is founder/GP fit.”
— Anonymous LP, $30B AUM Fund
“I look for someone who’s very consistent. They have the integrity to stick to their word. They’re not deal-chasing, deploying all their capital in less than two years, and trying to raise their next fund too quickly. Typically, you’re signing up for multiple funds. If the deployment window is very small, the GP makes frequent capital calls, which means you’re committing more capital in less time.”
— Sam Huleatt, On Deck
“TVPI and IRR tend to be lagging indicators, not leading ones (for many reasons — including irrelevance of these metrics earlier than 5 years, changing motivations, engagement, and so on for investors, and shift in fund size/strategy, noting the Maples Dictum that your fund size IS your strategy).
“For me, the thing that tilts the odds in favor of a manager having the potential to be ‘great’ is that they are leveraging some sort of ecosystem. That can be an ecosystem built on years of success (Sequoia) or ‘prepared mind’ like Accel back in the day, or deep entrenchment in a mafia (Founders Fund). Additionally, some people build fertile ecosystems like First Round or True by investing time and attention in targeted and intentional ways. I try to look for people that are entrenched in some kind of robust ecosystem and match the moment when their upward-sloping line of experience as an investor intersects the (generally) downward sloping line of hunger. For more specifics on my thought process, see the most recent (five years old LOL) post on Super LP.”
— Chris Douvos, Ahoy Capital
“Over the long run of course, it’s DPI, but it’s about consistency of returns, which typically is a byproduct of them understanding where their definable edges (finding product/market fit), and ruthlessly exploiting those edges through building repeatable processes on sourcing, decision making, team building, etc.”
— Samir Kaji, Allocate
“This portfolio can’t be a one-hit wonder. Is there enough gold in the middle after you take the top two and the bottom two investments out?
“There’s a Rome in everyone’s future. You go up and then you go down. There are many funds that generated outsized alpha in the last decade but are not what they used to be.
“If you’re leveraging a network, is that alumni network today the same as it was yesterday. Did most of the smart, driven people leave? Are you borrowing or are you using that network? Were you there at the right vintage?
“Also, bet on people who do what they said they would do. Where did the returns come from? If the top returns came from their 20% discretionary funds, and not their 80% core fund, is that something worth betting on again as an LP? I would rather back a 3x return from an on-thesis fund than someone who gave me a 6x who came from off-thesis. The latter is because it came from sheer dumb luck. The question is, what do they do with that dumb luck? Do they pivot and learn, or continue to go rogue / play the roulette?
“Think about why LPs give money to GPs. Anyone can go into Vegas and play the roulette. The best GPs can do something I cannot do and they do it repeatedly.”
— Asher Siddiqui, Sukna Ventures
Access > proprietary deal flow
“We have felt for a number of years now (including pre-COVID) that the concept of ‘proprietary deal flow’ is not really a thing. Proprietary access however is something we think is true, powerful and not simple to achieve (hence why powerful ).”
— Beezer Clarkson, Sapphire Partners
“I look for emerging managers who have a highly differentiated platform offering or differentiated deal flow. In addition, for someone who has won before, like winning great deals, they’re likely to win again.”
— Sriram Krishnan, Kearny Jackson
“For an emerging GP, it’s all about access. Do I have the confidence that the best founders will seek out this GP?
How I evaluate access for a solo GP is different from how I evaluated a platform. For platforms, their external brand plays a big role. What are other founders saying about them? I talk to founders they’ve backed because ultimately, founders are their customers.
For solo GPs, I evaluate the GP on their personal brand, and his or her own insight on how they are thinking about the fund as a product. Here, I think of it as more of a bet on the founder of the firm, and not a fund bet.”
— Gautam Shewakramani, Inuka Capital
“GPs also need to be able to quantify that unique access. I’m an LP in a fund that puts on a regular conference and runs a community of 30,000 [redacted job title]. Their thesis was that they’re going to fund the best ideas that come out of their [redacted] community.
“The same is true for Packy McCormick. His thesis is: ‘I help startups tell their stories. I have all these readers who are VCs and founders, and they’re going to invite me into their deal.’ So, the quantitative thing is how big is his mailing list and how fast is it growing.
“It’s the ability to quantify things that you as the GP think are proprietary about your particular access to this market segment. It’s more than just how many LinkedIn friends you have or how many Twitter followers you have; it’s specific to your thesis.
“For my thesis, I get referred deals because I’m an LP in 17 funds. I invest in deals that are too early for these other funds, and I can get them follow-on financing because I know directly the LPs in the follow-on funds. And the fact that I’m an LP in 17 funds gives credibility to that thesis.
“One of my theses is that I’m a really good pre-seed investor because my companies get a higher percentage of follow-on financing than your average VC. Mine is 72%. Techstars is 30%. I’m two and a half times better than Techstars at getting follow-on financing.”
— Martin Tobias, Incisive Ventures
“I’m an LP in 17 venture capital funds, and it’s very clear what separates the best from the good. Deal flow.
“I also think we are entering a new era where you’ll see specialized, smaller funds that will generate great performance because of domain expertise and proximity to the nucleus of innovation. I get really excited about this group, and think some of these <$50M funds could generate 5x+ returns.
“For this group, I look for two things:
The team climbing the hill: Why is this team special in being able to attract great deal flow? Examples could be knowledge expertise, distribution, prior experience, geographic coverage, but a compelling edge is critical.
The hill that team is climbing: Ultimately, macro matters a lot. We like to attribute performance to skill, but timing, sector, and luck play a large part of success. The worst manager in crypto in 2015 probably did pretty well. The worst fintech manager in 2010 probably crushed it. I think about what will be the area in 2030 that everyone wishes they had exposure to today.”
— Vijen Patel, 81 Collection
They don’t have to ask “How can I help?”
“Most investors are not helpful. I started a company, raised some VC money, then some from angels. And I realized that our most helpful investors were angels. I came to understand that there are two kinds of helpful investors:
Reactively helpful
Proactively helpful
“For the former, you would have a problem, reach out to your investor, and they would really help you. For the latter, it’s Alex. Alex was one of our first investors. He would often come into our office, and without being prompted, proceed to write code against our APIs. And I thought, if I were to be a VC one day, I wanted to be just like him — very hands on. I knew he would be a real value-add investor.”
— Brent Goldman, Lancelot Ventures *Alex is a fictitious name of a real person.
“It boils down to three questions that are all interrelated:
Does this fund manager have a brand?
Does he/she have access? Do founders need them more than the manager needs the founders?
And does he/she have something unique to provide to founders?”
— Shiva Singh Sangwan, 1947 Rise
“At the pre-seed level, where I invest, a great fund manager is someone who gets a startup to a ‘real’ round of funding. I think it’s like fording a river: a good fund attracts founders to their boat, then ferries them across to the other side. For this service, they are rewarded with allocation in a round that’s underpriced once they reach the shore.
“Great funds are ones that have a sustained, repeatable process for attracting founders and a reliable methodology to get them across. This can look like focusing on a geography, focusing on a sector, focusing on an underserved founder market, acting as a scout for a larger fund who likes your deals, or some combination of the above.
“The returns from pre-seed are really about getting early and cheaply enough to have made the risk worth it.”
— Paul Griffiths, 15 & Change
Are they hungry?
“I work with some good fund managers, but why are they not great? Why are they only in the top quartile, and not the top decile? They have all the ingredients of being great. They have amazing pedigree, and they went to the right high school, the right college, and worked at all the top startups in their vintage. But… they’re not hungry. They haven’t had enough adversity in their life.
“I have seen prospective LPs only look at a GP’s career history, and not their life history. You need that extra data point, that context. To take a holistic view of the unique set of experiences of a human being, and not just the professional. You look at their thesis, and their history; you look at it from birth to today; you look at their whole life and career history, and look at their thesis. If the thesis doesn’t make complete and perfect sense, then I don’t think this is a ‘great‘ fund manager. If it fits like a glove, then yes, they could be.
“I don’t believe in luck. I believe you create your own luck. How do you create your own luck? You create chaos, which creates opportunities — you then leverage your past experience and your drive to capitalize on that opportunity….”
— Asher Siddiqui, Sukna Ventures
The devil is in the details of their portfolio construction model
“They need to have thought about deployment (schedules) and fund size. One of the quotes we both like is ‘Your fund size is your strategy.’ A fund of $10 million should have a very different strategy than a $50 million or $100 million fund.”
— Sam Huleatt, On Deck
“To us, the difference between good and very good is portfolio management. How do they think about reserves to follow on? Do they look to increase allocation into the winners?
“There’s a big difference between managing a $5 million fund and a $20-30 million one and $500 million one. How you look at portfolio management and allocation is different. Everyone tells you they can give you a 5x return, but I only need 3x DPI! Even the best firms out there struggle to return 3x on certain funds.
“Your size is your strategy. We take into account the geography you invest into. In Israel, we don’t have decacorns. And because the exits are lower, the fund size should also be lower.”
— Itay Rotem, EdRITECH
Mixed references are not as bad as you think
“I’ve backed a lot of funds across the private markets, in both private equity and venture capital, and great investors may have divisive personalities. You want to back special talents, and they may rub people the wrong way. That said, there is a difference between a prickly personality and a bad actor not treating founders right, and not being ethical in their dealings.”
— Anonymous LP, Private Wealth Management Firm
Does the GP have investor-market fit?
“Success builds upon success in venture. I’m never going to attract the best talent in the neobank or fintech space. They don’t know who I am and I don’t have true domain expertise. But if you’re doing something in retail or in hardware, I can really help and you likely know what Tide Cleaners is. Folks in retail find a way to get in front of me, and likewise, I can meaningfully help these companies. Product market fit applies to VC’s, too. And we don’t talk about this enough, but also LP’s.”
— Vijen Patel, 81 Collection
The best have long time horizons
“Luck aside, I index greatly on energy, fire, thoughtfulness, and passion. Some founders or operators raise a fund after an exit because they don’t know what to do next and have money in the bank. LPs need to discern as best as possible how committed these people are to the job of investing. How much does the GP resonate with the founders they’re backing?
“GPs who are only building, but don’t understand roughly what they’re building towards tend not to resonate with me. GPs who have founder friendliness talking points, but few examples of hard conversations with founders don’t resonate with me. I get concerned when GPs don’t appear to have an understanding of what kind of bet they’re actually making. The great GPs have long-run perspectives and are willing to adapt. Startups have to execute miracles to achieve great financial outcomes. I want to see GPs have a rough mathematical understanding of their bets based on their assumptions and stories. What’s a reasonable amount of capital to startups to their milestones, knowing your home runs are going to go much further than your initial projections? What does SaaS multiples going down from 10-15x to around 8x mean? Was the GP banking on elevated multiples persisting for the math to work?”
— @Cashflow_Cowboy
“I want to invest in people who are going to build multiple funds, so the long-term commitment to the space is critical.
“Every fund thinks they’re solving a unique problem – most are not. A happy outcome is backing a GP that you believe in, so I’d prioritize character over potential returns. At the end of the day, you’re getting into a decade-long relationship, so you’d better like the GP as a person, not just the asset class.”
— Paul Griffiths, 15 & Change
Luck is a skill
“The thing is everyone’s smart, and between the top decile and quartile, luck is a big differentiator.”
— @Cashflow_Cowboy
“The difference between top quartile and top decile is one of luck. I believe that it is impossible to predict ex ante.”
— Chris Douvos, Ahoy Capital
“Outlier performance is a combination of luck and skill (luck is needed for massive outlier funds), but the best fund managers require less luck to consistently outperform because they have well constructed operating frameworks.”
— Samir Kaji, Allocate
“In my early days in venture, I spoke with several investors on the Midas list. And every single one of them attributed their success to luck and timing. They still view themselves as learning and actively track their anti portfolio to see what they missed. They’re humble, and still suffer from imposter syndrome. When I ask them these two questions:
Which were the startups that you thought were going to be winners?
What startups put you on the Midas list?
“There will be some overlap, but more often than not, it’ll be a different set of names. Investing in GPs is a bit like startup investing. It’s a bit of a roulette wheel. What you’re doing is improving the odds. Any LP or GP who says otherwise is full of shit.”
— Asher Siddiqui, Sukna Ventures
The best change the status quo
“I believe great GPs aren’t just impacting the success of their portfolio companies and their LPs, but are changing entire systems that are historically pretty broken in the VC ecosystem. The vast majority of LPs, VCs and funded founders have tended to be pretty homogenous in terms of the identities they hold and approaches they take to building & funding companies. By breaking through those biases and pattern matching, not only will a new kind of emerging fund manager see better returns, but they’ll also dismantle a lot of the systemic inequities that have prevailed. TL;DR: Good managers see healthy returns, great managers see those returns and leave things better than they found them. (I wrote a bit about some of those inequitable systems here if you’d like to link to it)”
— Rebekah Bastian, OwnTrail
GP Red Flags
Logo and trend shopping
“There is a concept of just logo shopping. A lot of decks are loaded up with a bunch of logos of great companies that the GPs have invested in the past.
“There are people who say they’re seed investors were able to get a slice of allocation of some hot company at the Series C or Series D for a $5,000 or $10,000 check. There’s nothing inherently wrong with that as an investor. But the way that it’s framed often looks like that they were seed investors in these hot companies as well.
“So, there’s some of that window dressing. I think that is a red flag. It just is on the edges of honesty that I’ve never really liked.”
— Eric Bahn, Hustle Fund
“When GPs claim to invest in a deal, one red flag is when they were only an angel in a syndicate, and the founders don’t even know the investor by name. We also look at deal attribution for GPs from bigger funds. How involved were they in winning deals at their last fund? So, we do backchannel checks.”
— Anonymous LP, $30B AUM Fund
“I’m wary of trend followers. People who follow trends without having anything unique to add to founders building in the space.”
— Martin Tobias, Incisive Ventures
Not playing the long game
“Another [red flag] is when GPs change the terms when fundraising. As a GP gets more interest, we’ve seen some GPs change the terms – from 2% fees to 2.5 or 3%. It raises some concerns that they are opportunists which might be viewed as a sign that they weren’t committed to building a long, durable fund.”
— Anonymous LP, $30B AUM Fund
“There is never a full alignment between LPs and GP. There are many potential conflicts when it comes to VC management. You don’t want to invest in people who will not hesitate to screw you. Don’t invest in people you don’t trust. There’s a thin line between greediness and discipline. We don’t invest in investors who are too opportunistic. Discipline and strategy consistency (with an amount of flexibility) is important.
— Itay Rotem, EdRITECH
“Too many GPs today are obviously dilettantes. The average fund lasts twice as long as the average American marriage, so it’s a long-term commitment to your partners. I get the sense that a lot of new GPs are becoming VCs in the same way a lot of college kids end up going to law school: it just seemed like the next obvious thing to do/the path of least resistance.”
— Chris Douvos, Ahoy Capital
“This is personal for each LP. I believe the GP’s job is to maximize returns for their LPs. So, there’s a tradeoff between GPs playing the long game and having a fiduciary responsibility to return money in the short run. So, a red flag for me is when the GPs don’t play the long game.
“There’s this weird nobility in venture, especially in the pre-seed. Sajith Pai wrote a great piece on this. Your first investor is almost like a priest. As the first check into a company, you should be a good priest. Is this person someone who will be a strong supporter of the founder, which could come at odds with short-term financial return? I won’t get immediate distributions. But at the same time, over a fund life, this could generate better financial returns across a portfolio of founders or in the form of access to better deals driven by reputation or founder friendliness.”
— Gautam Shewakramani, Inuka Capital
“People say they’re going to deploy over the next 2.5 years. But guess what everyone did in 2021. They deployed their entire fund. So LPs are asking, ‘What are you doing? We had all of this scheduled out, but you deployed so quickly, and so now we’re out of money. We can’t do your re-ups for next year, or we can’t back new managers right now.’ It’s been a real issue that has kept so much money on the sidelines.
“Saying you’re going to do something, then not doing it is a huge red flag. Do what you say you’re going to do. This is a relationship game. If you’re breaking trust, you’re playing the short game instead of the long game.”
— Vijen Patel, 81 Collection
Small funds, big reserves
“I’m wary of small funds with big reserves. For example, a $50 million fund with 50% reserves. What it means is you’re getting less shots on goals. For Fund I’s, it’s all about shots on goals.”
— Martin Tobias, Incisive Ventures
They lack honesty and self-awareness
“A big one is a lack of openness of what didn’t go right. Some GPs exhibit a lot of arrogance. They claim they’re great at everything. That’s not possible, and definitely not true. Everyone has flaws, but the inability to share them is a red flag for me.
“Good GPs are also very self aware of what they are and what they aren’t. These GPs manage their time well. They find partners to build a team that has complementary skill sets to their own. When I ask: Why are you not winning deals?, they have a great answer. If they can’t answer that, they probably have work to do understanding their own pitch. Moreover, the best GPs are consistent with their stories while open and willing to evolve.”
— @Cashflow_Cowboy
“For funds I declined to invest in, it came down to the person. They often take credit than share credit. I doubted their skills and ability to follow through. A lot of projects were often started but never finished.“
— Brent Goldman, Lancelot Ventures
“Managers that don’t appreciate that this is a journey, not a sprint. It’s the same as assessing a startup founder. We look for behavioral cues: approachability, willingness to accept feedback, and ability to go through pivots.
“At Revere, we share our ratings for GPs with our GPs. Say I give someone a four out of five on team, and they come back and insist on five out of five across the board. How receptive the GP is to constructive feedback (and address it) is a very telling indicator.“
— Eric Woo, Revere VC
“Usually GPs are really good at (typically) 2 or at most 3 of the following 6 things, in order to be top-decile:
Portfolio construction & management
Access to deals / networking
Ability to win deals
Company selection / financial analysis / assessing PMF and future value accretion
Active management to “add value” to those companies
Exits
“… And maybe fundraising / cost of capital.
“But if they aren’t aware of what they’re good at, that’s troubling. Once they know what they do to excel (and what they won’t) they usually become very good at focusing on what matters.
“Here are some examples:
Potential GP: ‘I am really good at all 6 GP characteristics above!’ Me: ‘Don’t call me, I’ll call you.’
Potential GP: ‘I am really good being a board member, I’m the best. I can make any shit company successful once I’m involved. I did this for three eCommerce companies in the 1980s, and I really think I can ‘turn around’ and exit eCommerce, adtech, fintech, digital health, AI / ML, beauty and fashion, etc. They’re all the same.’ Me: ‘Ummm…’
Potential GP: ‘I am great at deal sourcing from XXX network, and I specialize in AI. But vertical-wise, I see a lot of stuff, so I do a lot of stuff.’ Me: ‘Cool.’
“I also like to see more focused funds. A lack of ability to zero in on a particular thesis (e.g. B2B SaaS with certain characteristics) is at least a yellow flag, though if the GP’s core competencies support a generalized approach that’s fine.”
— Aman Verjee, Practical VC
The GPs are too founder-friendly
“Emerging GPs tend to be too founder-friendly. A great VC is like a personal trainer, not a cheerleader.”
— Chris Douvos, Ahoy Capital
There’s no follow-on strategy
“Another red flag is not having a follow-on strategy. If you’re a small fund, you are funding companies that will never get to profitability with the money you gave them. So they all have to raise additional financing. If you don’t have reserves in your fund, you need to prove that you know other funds or have an SPV or angel network that can fund your companies. If you don’t have an answer for how you’re going to be able to fund the companies in the next round or at least introduce them, that’s a flag.”
— Martin Tobias, Incisive Ventures
The follow-on SPVs take management fees
“They’re charging excessive fees on SPVs to LPs. Many LPs who invest in small emerging managers are in part doing so because they want the co-investment opportunities. And those co-investment opportunities should be at fairly favorable terms. The most favorable terms I’ve seen are zero and ten. I’m not saying everyone has to do it at that, but I have seen VCs try to do it at three and thirty – at premium terms relative to the fund. I think it’s a flag on the emerging manager if he/she is proposing to charge management fees on SPVs at all.”
— Martin Tobias, Incisive Ventures
They lack communication skills
“GPs sometimes don’t follow up with what the LP asked for. The follow up is very generic. For example, if the LP wants to co invest in XYZ sector, can you send names in the portfolio that might be interesting to them?”
— Anonymous LP, $30B AUM Fund
“Bad communicators who only answer with curt and short responses is a red flag.”
— @Cashflow_Cowboy
They don’t know the numbers or the rules of the game
“Plenty, but to extract one, we’ve found that managers that don’t know the numbers (i.e. what enterprise value within your portfolio will you need to get to a 3x+) is a huge red flag and leads to poor portfolio construction and decision-making. Saying you are going to return a 5X+ easily is not respecting how difficult it is, and probably comes with a lack of understanding of basic fund math.”
— Samir Kaji, Allocate
“Managers that don’t understand basic portfolio construction and fund modeling. You would be amazed how many don’t even have a spreadsheet that tracks current investments.”
— Eric Woo, Revere VC
“Emerging GPs tend to overestimate the value of prior experience and underestimate the value of investing skills like portfolio construction and discipline (not just on things like price, but also on things like security selection — for instance, not understanding the problems with SAFEs).”
— Chris Douvos, Ahoy Capital
“If they are carrying companies at valuations that seem out of whack, or indefensible (or if they can’t really articulate their valuation policy) that’s no bueno. That is ALWAYS a signal that the GP is not going to be aligned with me… I’ve known some very strong investors who have played this game and it’s a real problem for me personally.”
— Aman Verjee, Practical VC
They play the AUM and management fee game
“I think fund size is a real issue. The law of funds is really interesting. If you get a million-dollar allocation early on into a unicorn and it’s a smaller fund, you can return the fund multiple times over. If you do that with a $400 million fund, it’s harder to make those numbers work.
“So as an investor, you can play one of three types of games:
You can spit out rapid funds.
You can raise massive funds.
Or you can make massive carry.
“The amount of funds and management fees that have been raised recently are out of control. If you can think about taking 2% management fees on a $500 million fund – and obviously you got costs and expenses – you’re bringing home an annual income of $10 million. And that’s just one fund, and you do another and another. So, are you trying to create value or play the AUM game? And that is a red flag for me. I like small, steady, disciplined managers who are deeply passionate about early-stage and a certain sector. That typically means they won’t scale to a $1B fund.”
— Vijen Patel, 81 Collection
No investing experience
“Just like the only way to get good at wine is to drink a lot of wine. The only way to get good at investing is to see a lot of deals. A red flag would be a GP with no investing experience.”
— Lo Toney, Plexo Capital
Common Advice To Ignore
While far les prominent than investors advising founders on how they should run their business or startup investing advice at broad, there’s a small handful of commonly shared pieces of advice that new LPs often get. Certain pieces of advice might serve larger LPs who work with a different set of parameters than you do. The important part is understanding the why.
Having artificial timelines
“LPs also shouldn’t give artificial timelines. Most family offices and individuals don’t have deployment schedules. A big endowment, like Harvard, does.”
— Anonymous LP, $30B AUM Fund
The same is true for LPs as it is for GPs: Chasing logos
“Just because you spun out of a big firm doesn’t mean you’re going to do well as a new firm. These emerging managers are going to look good on paper, but they might not necessarily know what it’s like living in a chaotic environment. It’s not the same environment they grew up in when they were at a16z, or had another great name behind them. Different resources, different support, so different mentality. Connection with founders is incredibly important and you want to understand how that applies in a different environment.”
— @Cashflow_Cowboy
“I don’t know if this is advice that is shared, but many LPs over-index things like logos, GP commits, and early fund performance (which means very little within the first 3 years).”
— Samir Kaji, Allocate
“A big one is around geographic and pedigree bias. There is a trope that’s formed that if you’re a founder of GP that’s based in the San Francisco Bay Area — maybe went to Stanford or Harvard or MIT, that will position you into the very best networks to be successful.
“I’m not saying that just because you possess those characteristics that you can’t be successful. In fact, there are plenty that are. But there are also are a lot of really talented people outside of those networks too.
“I think a lot about this Warren Buffett rule: ‘To make a lot of money, you have to be both contrarian and right.’ Look a bit more widely in your funnel and invest in managers who don’t look like yourself and come from non-traditional networks and backgrounds. They’re identifying founders who may be working on some pretty amazing stuff that’s being overlooked.”
— Eric Bahn, Hustle Fund
Diversification for the sake of diversification
“Many emerging LPs are told to look for differentiation, but some things are differentiated in how bad (or mediocre) they are. Hedge fund managers say they’re seeking alpha, but sometimes you find it and it has a negative sign in front of it. What really matters is sustainable competitive advantage. How do you demonstrate and articulate your SCA? What is your unfair advantage in an extremely noisy market (and it’s gotta be more than just: ‘we’re part of the SF cool kid crowd/look at our AngelList track record of $50k checks’).”
— Chris Douvos, Ahoy Capital
Should you bet on emerging GPs?
“‘Stay away from Fund I/II.’ This is the wrong advice. Don’t underestimate new GPs. Being a new GP is like being a founder; it’s a long-term commitment. And two, stay away from GPs who don’t have resilience and are not hungry to win.”
— Cindy Bi, CapitalX
Do ownership targets matter?
“There’s a lot of surface level ‘buyer beware.’ Everyone talks about ownership targets. ‘Are you hitting your ownership targets?’ For large funds, that 15-20% ownership matters. You want the proceeds of the outcome to meaningfully impact the fund. Ownership is less important for a first or second time fund, which are smaller funds where a single great outcome, even at low ownership, can return the fund.“
— Eric Woo, Revere VC
Using fund-of-funds to get into emerging funds
“I would encourage a lot of emerging LPs to not go into fund-of-funds. As an emerging manager, I want fund-of-funds to invest in my fund. But as an LP, you get double-feed. If you’re going to invest into venture funds, invest directly in the manager yourself.
“What the fund-of-funds will tell you is that they can get you into funds you can’t get into. I’m also starting to see fund-of-funds for emerging managers, which I think is a great thing. For incredibly large LPs, I think it makes sense. They get access to someone else who’s going to do all the diligence on emerging managers. But that’s not for an emerging LP whose check size is $250K to a million dollar LP commitment. Fund-of-funds are for people with a billion dollars who are already invested in Sequoia and are writing $5-10 million checks.
“Typically you would pay one and ten for fund-of-funds. Then that fund-of-funds pays two and twenty. So you’re three and thirty behind as a fund-of-funds LP.
“For emerging LPs, it’s a good exercise to invest directly in emerging managers because it’ll help with your direct investment practices as well. If you invest in fund-of-funds, you’re never going to have those co-investment opportunities because you never build a relationship with the manager.“
— Martin Tobias, Incisive Ventures
Additional Tactical Tips
The below are tips that everyone were kind enough to share, but didn’t fit into the above categories. Nevertheless, I find them to be powerful in expanding how you think about being an LP.
You’re never too good to reach out.
“I will say about a third of my LP investments were into fund managers I never worked with before. I hear of these new GPs from talking with my network. If I like what they do, I’ll reach out via Twitter.”
— Sriram Krishnan, Kearny Jackson
“For every fund I’ve been in, I reached out to them, not the other way around. Every time I invest in a fund that’s either because I know the GP personally, or I know someone who knows the GP.”
— Brent Goldman, Lancelot Ventures
See if the GP has flexibility on the minimum check size
“One thing that can be helpful to know for first-time LPs: GPs often have some flexibility on their minimum check size. I’m a pretty small check (particularly since I’ve been living on a founder salary!), but I can bring other things to the table to help the GPs I invest in (e.g. I highlighted Janine Sickmeyer from Overlooked Ventures in my Forbes column, I’m an advisor to Zecca Lehn from Responsibly Ventures, I send them deal flow from my AuthenTech community of founders). I’ve had luck with reaching out and saying ‘I really believe in what you’re doing. Please let me know if you get enough large checks and have room for some smaller LP investments.’ They’ll usually need to get enough big investments first since there are SEC limits on how many LPs they can have, and then they can let in some smaller, value-add LPs.”
— Rebekah Bastian, OwnTrail
There are multiple ways to do reference checks
“There’s a two-part reference call check that I love that I learned from Scott Cook, who is the founder of Intuit. You ask, ‘I want you to tell me about David. Rate him from 1 to 10. 10 being absolutely perfect, and 1 being horrific.’ And you can basically ignore everything that is said. Most people say 8 or 9. You know they have their answer prepared.
“But then the second question is, ‘What will get David to a 10?’ And that’s where you hear the truth. That’s where you can pay attention.”
— Eric Bahn, Hustle Fund
“Investing into a fund is much like investing in startups. Why does this person have an unfair advantage over everyone else? I talk to the founding GP. I read VC Guide – think Yelp reviews for investors by founders. And if I think the team has an unfair advantage, I invest.”
— Brent Goldman, Lancelot Ventures
“Ask to talk to other current LPs – you can learn a lot about how you will be treated once the fund has your money.”
— Paul Griffiths, 15 & Change
“Being an LP is a ground game. It requires talking to founders and co-investors, and you won’t get much from surface-level reference checking.
“There’s no specific number that I shoot for. I once heard an LP claim to have completed 80 reference checks for one commitment. To me, that seemed like they were doing diligence for the sake of doing diligence. You could have gotten to the same answer well before 80. I reached close to 20 checks in diligence on a fund once, but I often need far less than that. The more important thing is you’re answering the questions you have that pop up in your diligence, that you only do whatever references that you need to get to a yes or no.”
— Anonymous LP, Private Wealth Management Firm
“We are all operating in the business of emotions and trust. It’s best to build trust by word of mouth or references. I’ve never invested in a fund without talking to another manager or entrepreneur in the portfolio. This is across the stack. Top $100B asset managers do 20 back references on $100M venture capitalists. $100M venture capitalists do 20 back references on $10M start-ups. And $10M start-ups do back references on employees. Together, with the bond of trust, this system creates an impact on the world.
“In practice, for example, I don’t have a lot of domain expertise in web 3, but I have plenty of friends who do. So before I invested in [name redacted], I called four people and they all told me this manager was one of the top five.
“This is the under-pinning of asset allocation, but unfortunately this also leads to systematic issues. In fact, I would say this referral network is part of the issue of neglected founders, industries, and geographies not being able to get funded. It’s a huge issue in our country that 2% of women get all VC dollars. That’s horrendous and that means that >50% of our population only gets 2% of funding. That isn’t right. We need more capital to flow to underrepresented or neglected founders or industries or managers. These new managers may not have the network to build traction, but I’m loving all the new amazing, specialized emerging managers doing great work with new strategies popping up.”
— Vijen Patel, 81 Collection
“Do reference calls. Talk to some founders they’ve invested in. Talk to startups in their anti-portfolio. And talk to some of the founders that didn’t work out. For the latter, how did they manage that? What do the founders think of them? If you only talk to the winners in their portfolio, they look like cheerleaders who got lucky and got into some great companies.”
— Asher Siddiqui, Sukna Ventures
Follow-on investors aren’t as big of a differentiator as you might think.
“Top-tier follow-on investors in the past 48 months are no longer a differentiator. Existing managers all talk about mark-ups. Most managers that aren’t incompetent have markups and brand name follow-on investors over the last three years.”
— @Cashflow_Cowboy
Get granular with a fund’s follow-on investors
“A lot of LPs act like they care about which funds are making investments alongside emerging managers. But who those follow-on investors and co-investors are will mean different things to different people based on the following factors.
Which partner at that established fund is actually leading the deal? Is it someone with a track record or a more junior partner?
Which fund are they investing from? Is it their core fund, or a satellite one they’re experimenting with?
“You ultimately need to get to know the people behind every investment decision.”
— Anonymous LP, Private Wealth Management Firm
March 30th is more important than you think
“Ask when you will get your K-1s and insist that it is before March 30th, otherwise you will be stuck extending every year and that’s just a pain.”
— Paul Griffiths, 15 & Change
Don’t rush into investment decisions
“We don’t rush into investment decisions. It takes us time to reach conviction. Unlike early stage VC, in a fund-of-funds, you expect returns from all your investments. Conviction is required to reach trust. We might not rush into the first vintage, but based on how well we get to know the fund manager, might jump into the second vintage.”
— Itay Rotem, EdRITECH
“There are also a lot of venture funds out there, take your time and meet with a range of GPs before you invest to get a feel for what the investment opportunities are and what feels right for you for your LP program.”
— Beezer Clarkson, Sapphire Partners
“Yes, meet at least 20-30 managers before you make an investment, or use a partner. Like anything, at first you will like almost everything, but it takes reps to truly start to build pattern recognition, and manager investing is a probability based exercise; meeting just a few won’t provide enough data points to have a good sense of what meaningful differentiation looks like (i.e.. meaningful differentiation increases the probability of consistent success, much like counting cards in blackjack. It doesn’t guarantee a payout, but you want someone that has their own version of ‘counting cards’.”
— Samir Kaji, Allocate
“Emerging LPs shouldn’t be taking any advice or making any decisions until they’ve met with at least 100 investment firms (and as many different types of firms as they can).
“The reality is that LPs don’t help each other as much as they should. There’s this cooperation versus competition dynamic, this friendly competitiveness, and LPs will be more helpful in less access-constrained deals. That’s something you need to understand as a new LP.”
— Anonymous LP, Private Wealth Management Firm
TVPI hides good portfolio construction
“When I do portfolio diligence, I don’t just look at the multiples, but I look at how well the portfolio companies are doing. I take the top performer and bottom performer out and look at how performance stacks up in the middle. How have they constructed their portfolio? Do the GPs know how to invest in good businesses?
“I’m not just bothered by my TVPI. I also try to look at the companies and the revenue they’re bringing in. Some of a fund’s portfolio companies that haven’t raised a subsequent round, which may not look as good in TVPI, but they may not have needed to raise any subsequent capital to scale further. The point is to assess the quality of the underlying portfolio of ‘businesses’ — so factor that in and look at likely exit opportunities for those companies.”
— Asher Siddiqui, Sukna Ventures
Don’t invest in ESG for the sake of ESG
“Avoid ‘ESG’ if they reduce financial returns, are comprised of unaudited made-up metrics that won’t get reported (e.g. ‘we love the environment, and will only invest in ‘green’ companies’ but the LPA doesn’t provide mention of reportable, audited environmental goals or KPIs, or define what ‘green’ means).”
— Aman Verjee, Practical VC
Past performance is not indicative of future performance
“It takes three funds worth of track record to make it meaningful. But even then, it’s even more complicated. Your strategy and risk-to-return profile for a $5 million Fund I will look meaningfully different than yours for a $150 million Fund III. I wouldn’t recommend relying on these blunt instruments for the emerging manager category. So the advice here is that LPs cannot rely on past performance of earlier funds if the latest fund’s strategy has shifted.”
— Eric Woo, Revere VC
Have an LP thesis
“LPs should have a portfolio construction model. What percent are you investing in generalist funds? What percent in thesis-driven ones? And also, what stages? Pre-seed? Seed? A- and B-funds? Multi-stage?
“You should take the total amount you want to put into funds and separate it with a portfolio construction model that makes sense for your risk tolerance.
“Is your portfolio allocation driven by financial returns or certain goals you have? A lot of LPs might want to invest for non-financial reasons – could be diversity, geographic coverage, verticals, or stage. They might want to support female founders, or ESG. Just like I encourage angels to have a thesis, LPs should have one too. Why am I doing this?”
— Martin Tobias, Incisive Ventures
Why are you helpful as an LP?
“As an LP, you also have to think of your unique value-add. If you have a brand, your name helps with credibility of the fund and helps the GP reach more LPs. On the other hand, you have to think about what kind of LPs a GP would offer their pro rata rights to? For an SPV strategy, those are LPs who:
Backed and believed in the GP from Day 1.
Has written big checks, and/or
Can help the fund’s portfolio companies.”
— Shiva Singh Sangwan, 1947 Rise
“We did have several of those established, persistent performers in the PE/VC portfolio in my prior role though, and that’s because those GPs look for more than just money. They may be looking for someone who’s strategic to their portfolio, but more so they’re looking for kindred spirits. Show why you’re also a convicted investor, like them, because they’re really just looking for true believers.”
— Anonymous LP, Private Wealth Management Firm
Don’t put your eggs in one basket.
“Putting money into an early-stage fund is a very, very high-risk alternative asset category. Every normal family office puts maybe 10 to 15% of their total net worth behind this asset category. Don’t concentrate behind a single manager. Spread it across five, possibly ten, managers who have truly varied networks.”
— Eric Bahn, Hustle Fund
“Invest in a larger number of fund managers than you might think is appropriate. Focus on smaller, tightly managed micro-VCs (I’m assuming that the LP can’t get into the Sequoia / Founders Fund / Benchmark types). Really dig into their strategy, their edge, and their pipeline. And, spend time with them and learn the trade, get into their co-investment program and be ready to execute!”
— Aman Verjee, Practical VC
“Does it make sense to have 17 funds all in web3? Or 17 funds in fintech? Or even 8 in web3 and 9 in fintech? My own fund is counter-cyclical, and I think an LP needs to build a portfolio of top managers across the economy. Healthcare, IoT, fintech, web 3, and other differentiated strategies can comprise an excellent portfolio.
“If an entrepreneur is building in climate tech, there are 10 amazing funds out there who really know climate tech. If you’re building in web3, there are several funds that are so close to the nucleus of innovation and that’s what it matters. But if you’re building in hard industries, we’re trying to become one of the ten. A portfolio that consists of a basket of these top ten funds makes a lot of sense if you believe in investing in venture.”
— Vijen Patel, 81 Collection
“LPs can get very excited about tech and venture. They still need to remember this is a high-risk asset class. They should have clarity of what their expectations are. Venture used to traditionally be 5% of private equity. This is funny money – play money. It’s less so now, but still is. LPs do it because it has the potential to provide outsized, risk adjusted, returns.”
— Asher Siddiqui, Sukna Ventures
Patience is a virtue
“It may take seven to ten years (or longer) to see any real return, so be patient.”
— Cindy Bi, CapitalX
“The reason I chose a lot of managers is also so I can start tracking data. I won’t do re-ups right away because I want to see how they’ll perform over a couple decades or even over 6 years.”
— Vijen Patel, 81 Collection
In closing
The above is by no means all-encompassing as you refine your craft as an LP. Nevertheless, if you’re looking to dive deeper into the art of investing in non-obvious capital allocators, I hope this blogpost serves as a launchpad for your career. Make new mistakes rather than old ones. The world is better off learning from and supporting each other.
If you learned something from the above, I urge you to reach out to any of the above legends and share your appreciation with them. And if you employ any of their tactics, let them know how empowering it was.
Trust me, it’ll go a long way.
*I’ve made light edits to the above quotes for clarity and since my hand can only take so many notes per second.
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The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
