A quick thought on investing in generalist funds, inspired by a GP following up with me after I told him I prefer investing in “specialist” funds. Which he followed up with “I am a stage specialist.” Technically, he’s not wrong. But under that definition, almost all emerging managers are stage specialists. Their specialization just depends on which stage we’re talking about. But when most, including myself, use the word specialists, we really mean sector specialists.
A couple things to caveat before I go further:
- I’m an emerging LP. I don’t have that many years or funds I’ve invested in at this point, so I need to spread my coverage wider than after I figure things out. But not too wide that I trend towards the median, also known as “indexing venture.” Median, even top quartile in today’s venture, is uninspiring. And there are far better liquid options that can deliver the same return profile as top quartile in venture.
- I have a stage preference because I think it’s where you can build meaningful relationships while still figuring things out alongside the founder. As they say, a friend in need is a friend indeed.
- I have a geographical preference because of my existing network, which makes certain opportunities easier to diligence.
- I prefer sector specialists because I’m designing a portfolio where I can hopefully predict where 50% of my underlying portfolio will come from, and 50% where I can’t. Since most things in venture are opportunistic, and I give each of my managers that longer leash to make bets to be opportunistic (20%-ish; not a hard number, but can’t be 70%). Specialists are easier to underwrite how valuable they can be to a portfolio. Generalists, it’s harder to, unless I’m somehow convinced that a GP has a unique skillset I’ve never seen before in my career so far, which the bar just gets higher the longer I’m in business, AND that skillset is uniquely valuable to a founder across sectors.
I want to have exposure to 50-60 new companies/opportunities per year, with very little overlap. Stats suggest 30 of a sample size becomes statistically significant so anything less than that, I’m not giving my null hypothesis an honest chance. If I believe that 20 companies per year matter (not sure of the exact number, but this number feels directionally accurate), I want to know my managers collectively together has at least a 1 in 3 chance of hitting at least one. That means being in the right networks. Proportionally, some should spend their time hunting (i.e. actively spend time in interesting ways to find and chase after the best opportunities). Some should spend time fishing (i.e. building a brand so fish swim to or at least through their fishing hole). Some should spend time farming (i.e. cultivating relationships).
That said, my portfolio has yet to deploy into 50 new opportunities per year, so I am actively adding to it, in specific areas. Areas I don’t have good coverage over for now. So to invest in a new sector generalist manager, I likely need to “fire” one or more managers from my existing portfolio, which means I won’t re-up in them. And there are only a small handful o reasons I’ll won’t re-up into an existing manager.
- Their investments have really deviated off of the thesis I underwrote them to have.
- There’s a major team change that puts into question their ability to outperform.
- Their fund size has drastically increased to a point I question the return profile that would get me excited.
- They’ve made a series of bad bets where I question their ability to make decisions (i.e. I meet with their founders and they just don’t feel like high performers.).
- They lose motivation to be a VC and hang up the cleats. In this case, I won’t have to say the “no.” They will for me. But on occasion, they’ll try to raise another firm, or hear whispers on how tough the market is, and they’ll choose not to raise another vintage.
- I meet with a new GP covering an area an existing manager covers but materially better on almost all fronts. 10-20% better, even 50% better, is negligible, and also really hard to measure in foresight. And assuming the manager I’ve invested in learns quickly, that 50% gap will be closed shortly.
Luckily none of the above has happened yet. But I imagine, because I’m not perfect, at some point, one or some of the above will.
So if you’re a generalist covering 2-4 areas that my existing portfolio is covering AND has reasonable access to, in order to invest in you, I must believe that you’d be better than the firms I’ve already invested in, then subsequently fire them from my portfolio the next vintage.
That is a high bar. And only gets higher the more my portfolio grows.
Photo by Vitaly Gariev on Unsplash
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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.