Beezer Clarkson leads Sapphire Partners‘ investments in venture funds domestically and internationally. Beezer began her career in financial services over 20 years ago at Morgan Stanley in its global infrastructure group. Since, she has held various direct and indirect venture investment roles, as well as operational roles in software business development at Hewlett Packard. Prior to joining Sapphire in 2012, Beezer managed the day-to-day operations of the Draper Fisher Jurvetson Global Network, which then had $7 billion under management across 16 venture funds worldwide.
In 2016, Beezer led the launch of OpenLP, an effort to help foster greater understanding in the entrepreneur-to-LP tech ecosystem. Beezer earned a bachelor’s in government from Wesleyan University, where she served on the board of trustees and currently serves as an advisor to the Wesleyan Endowment Investment Committee. She is currently serving on the board of the NVCA and holds an MBA from Harvard Business School.
Chris Douvos founded Ahoy Capital in 2018 to build an intentionally right-sized firm that could pursue investment excellence while prizing a spirit of partnership with all of its constituencies. A pioneering investor in the micro-VC movement, Chris has been a fixture in venture capital for nearly two decades. Prior to Ahoy Capital, Chris spearheaded investment efforts at Venture Investment Associates, and The Investment Fund for Foundations. He learned the craft of illiquid investing at Princeton University’s endowment. Chris earned his B.A. with Distinction from Yale College in 1994 and an M.B.A. from Yale School of Management in 2001.
You can find Chris and Beezer on their socials here.
[00:00] Intro [03:07] Beezer’s childhood dream [04:29] How Chris was let go from his $4.15 job at Yale [08:09] Concentrated vs diversified portfolios [09:30] First fund that Beezer and Chris invested [11:42] Funds that CD and Beezer passed on and regret [16:07] Favorite term in the LPA? Or not? [19:18] What piece of advice did a GP in their portfolio share with them? [23:15] What’s something that Beezer/CD said to a GP that they regret saying? [28:06] What’s the most interesting fund model they’ve seen to date? [33:20] What fund invested in 2020-2021 inflated valuations that they’ve reupped on? [40:18] Events that they went to once but never again [44:24] Life lessons from CD & Beezer [54:02] The founding story of Open LP [55:02] Thank you to Alchemist Accelerator for sponsoring! [57:58] If you learned something new in this episode, it would mean a lot if you could drop a like, comment or share it with your friends!
Tom Landry (who’s actually the correct attribution for the quote: “A coach is someone who tells you what you don’t want to hear, who has you see what you don’t want to see, so you can be who you have always known you could be.”)
“If you’re overly concentrated, you better be damn good at your job ‘cause you just raised the bar too high.” – Beezer Clarkson
“Conviction drives concentration, and that you should be so concentrated as to be uncomfortable because otherwise you’re de-worsified, not diversified.” – Chris Douvos
“[David Marquardt] said, ‘You know what? You’re a well-trained institutional investor. And your decision was precisely right and exactly wrong.’ And sometimes that happens. In this business, sometimes good decisions have bad outcomes and bad decisions have good outcomes.” – Chris Douvos
“Sometimes I treat GPs like I treat my teenage children which is: Every word out of a teenager’s mouth is probably a lie designed to make them look better or to hide some malfeasance.” – Chris Douvos
“May we be blessed by a weak benchmark.” – David Swensen
“Miller Motorcars doesn’t accept relative performance for least payments on your Lamborghini.” – Chris Douvos (citing hedge fund managers)
“At the end of the day, the return on an asset is a function of the price you paid for it and the capital it consumes.” – Chris Douvos
I am under no illusion that there is a hell of a lot of interest in the LP landscape today. Not only from GPs who are realizing the difficulties of the fundraising climate, but also from aspiring and emerging LPs who are allocating to venture for the first time. The latter of which also have a growing set of interests in backing emerging GPs. And in the center console in this Venn diagram of interests lies the education of how to think like an LP.
There is no shortage of content. LPs are also starting to make their rounds. You’ll often see the same LP on multiple podcasts. And that’s not a bad thing. In fact, that’s very much of a good thing that we’re starting to see a lot more visibility here and that LPs are willing to share.
But we’re at the beginning of a crossroads.
A few years back, the world was starved of LP content. And content creators and aggregators like Beezer, Ted, Nick, and Chris, were oases in the desert for those searching. Today, we have a buffet of options. Many of which share listenership and viewership. In fact, a burgeoning cohort of LPs are also doing their rounds. And that’s a good thing. It’s more surface area for people to learn.
But at some point, the wealth of information leads to the poverty of attention. The question goes from “Where do I tune into LP content?” to “If I were to listen to the same LP, which platform would I choose to tune into?“
After all, we only have 24 hours in a day. A third for sleep. A third for work. And the last competes against every possible option that gives us joy — friends, hangouts, Netflix, YouTube, hobbies, exercise, passion projects and more.
In the same way, Robert Downey Jr. or Emma Stone or Timothée Chamalet (yes, I just watched Dune 2 and I loved it) is going to do multiple interviews. With 20, 30, even 50 different hosts. But as a fan (excluding die-hard ones), you’re likely not going to watch all of them. But you’ll select a small handful — two or three — to watch. And that choice will largely be influenced by which interviewer and their respective style you like.
While my goal is to always surface new content instead of remixes of old, there will always be the inevitability of cross-pollination of lessons between content creators. And so, if nothing else, my goal is to keep my identity — and as such, my style — as I continue recording LP content. To me, that’s the human behind the money behind the VC money. And each person — their life story, the way they think, why they think the way they think — is absolutely fascinating.
In closing
There’s this great Amos Tversky line I recently stumbled upon. “You waste years by not being able to waste hours.” And in many ways, this blog, Superclusters, writing at large, and my smaller experiments are the proving grounds I need to find my interest-expertise fit. Some prove to be fleeting passions. Others, like building for emerging LPs, prove to be much more.
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.
I wrote a blogpost last year, where I went a level deeper into my NTY thesis. In short, in what situations and in front of what kind of ideas do I ask founders: Why now? Why this? And why you?
But let’s go a step deeper. As I’m writing another blogpost slated to come out next year, I’ve had the chance to sit down with some amazing multi-cycle investors. And a common thread across all those conversations has been that they chose to be the first check in companies that would be big, if true.
Which got me thinking…
If ‘big if true’ is for the preposterous ideas out there, then possible ideas would be ‘big when true.’ And plausible ideas would be ‘big AND true.’
Let’s break it down.
Big AND true
Not too long ago, the amazing Chris Douvosshared with me that the prerequisite to being “right and alone”, where fortune and glory lie, is to be “wrong and alone.”
Imagine a two-by-two matrix. On one axis, right and wrong. On the other axis, alone and in the crowd. You obviously don’t want to be wrong and in the crowd. But you do want to be in the right and alone quadrant. Because that’s where fortune and glory are at. Most people think that to get there, you must first start in the right and in the crowd quadrant. But it’s important to note, that once you’re in the crowd, and you get the dopamine hits of validation, it’s really hard to stray away from the crowd. So really, the only way to get to fortune and glory is to be wrong and alone. To be willing to go against the grain.
Unfortunately, for big AND true, you’re in the crowd. And while you can usually make money on the margins, it’s hard to be world-defining. ‘Cause you’re too late.
The thing to be wary of here if it is any investor’s strategy to deploy capital here is to not be the last money in. Hype and compounding are dangerous. And for many companies that exist here, they have a short half life. If you’re the last one holding the bag, that’s it.
Big WHEN true
You know that saying, “It’s a matter of when, not if…” it’s just as true in the innovation space. There are some things in life that are bound to happen. Recessions. Hype cycles. Rain. First snowfall. Summer heat. Progress. Maturity. When one’s baby teeth fall out. Wrinkles. Gray hair. Some with more predictability than others.
These ideas are defined as those with early commercial traction, likely with a niche audience or only your 1000 true fans. And that’s okay. Usually happens to be some of the toughest pre-seed and seed rounds to raise. There’s clearly traction, but no clear sense of rocket ship growth.
Timing matters. Is the larger market ready to adopt the beliefs and culture and habits of the few?
For some investors, it’s why they target quality of life improvements to the wealthy made ready for the masses. Living a wealthy lifestyle is, after all, aspirational for many. On the flip side, if you have a niche audience and are looking to expand, are there underlying beliefs and traits that the broader market has but has instead applied those beliefs and habits in other parts of their life?
Big IF true
Sam Altman put out a blogpost just yesterday, titled “What I Wish Someone Had Told Me.” And out of the 17 lessons he shares, one in particular resonated the most with me:
“It is easier for a team to do a hard thing that really matters than to do an easy thing that doesn’t really matter; audacious ideas motivate people.”
While the stories of Airbnb or Coinbase or Canva seem to suggest that these are nigh impossible ideas to raise on, anecdotally, I seem to find that the most transcendent companies with CEOs who are able to acquire world-class talent to their companies have less trouble fundraising than the ‘big when true’ ideas. But more difficulty raising than the ‘big and true’ ideas.
That said, instead of many smaller checks, you just need to find one big believer. In other words, the Garry Tan for your Coinbase or the Fred Wilson for your Twitter. One way to look at it, though not the only way, is what Paul Grahamputs as the “reasonable domain expert proposing something that sounds wrong.” Crazy, but reasonable. Simply, why you?
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 one of the recent All-In podcast episodes, Bill Gurley shared that both VCs and LPs aren’t marking down their portfolios. For GPs, inflated numbers helps you raise the next fund. For LPs, they’re given their “bonus on paper marks. So, they don’t have an incentive to dial around to their GPs and say, ‘Get their marks right.’ ‘Cause it’s actually going to reflect poorly on them if they were to roll those up.”
The last few years, enterprise value has been largely based on multiple expansion. The truth is we’re not going to see much of it in the incoming years. Even AI that’s exploding right now will see a contraction of their multiples in due time.
Companies that should not be in business today will see their ultimatum too in the next few years. Hunter Walk recently wrote “they’re 2017-2021’s normal failures clustered into current times.”
So, while some GPs do pre-emptively mark down their portfolio by 25-30% — we’re seeing this behavior more so in pre-seed and seed funds — the only people in this whole dance that are incented to mark down portfolios are new LPs trying to figure out if they want to commit to a new fund.
And while the advice applies to newer VCs, the same is true for experienced investors. Of course, most investors aim to be in the upper right-hand corner, but that’s really, really hard. In truth, most notable investors fall in two cohorts: marketers and tastemakers.
Marketers:
Share a high volume of deal flow,
Lower quality opportunities,
Have relatively low conviction on each deal compared to their counterparts, the tastemakers,
Have comparatively diversified portfolios,
And could have adverse effects on branding and positioning in the market.
Tastemakers, on the other hand:
Share a lower volume of deals,
Usually higher quality opportunities,
Higher conviction per deal,
Have comparatively more concentrated portfolios.
And the downside may simply be the fact that their volume may not warrant raising a fund around, and might be better off as an opportunistic investor.
And speaking of concentrated versus diversified, the interesting thing, as Samir Kaji shared on his recent podcast episode, is that “at 85 companies [in the portfolio], you had over 90% chance of getting a 2X. But a very low chance at getting anything above a 3X. And with smaller portfolio sizes [between 15-25 companies], there was much higher variance — both on the top and bottom. Higher chance that you perform worse than the median. But a much higher chance of being in the top quartile and even beyond that, in the top decile.”
It’s also so hard to tell what high quality companies look like before the liquidation event. Naturally, high quality funds are even harder to tell before the fund term. It’s ’cause of that that a few LPs and I wrote the post last week on early DPI. But I digress. At the end of the day, many, for better or worse, use valuation and markups as a proxy for quality.
But really, the last week’s valuation in this week’s market environment. Rather than chasing an arbitrary number, a lot more LPs when evaluating net new fund investments, and GPs making net new startup investments, care about the quality of the businesses they invest in. It’s not about the unicorns; it’s about the centaurs. The $100M annualized revenue businesses.
Samir Kaji’s words in 2022 ring true then as they do today. “Mark-downs of prior vintages are starting to occur but will take some time given valuation and reporting lags.” We’re still seeing many who have yet to go back to market. As many say, the flat round is the new up round. But until folks go back to market, there are many who won’t jump the gun in writing down their portfolio. But they are cautioning themselves, so that hopefully they won’t make the same mistakes again. The goalposts have changed.
I’m reminded of Henry McCance’s words channeled through Chris Douvos. “When an asset class works well, capital is expensive and time is cheap. What we saw in the bubble was that capital got cheap and time got expensive.”
We’re now back at a time when capital is expensive and time is cheap.
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.
Some of you reading here are busy, so we’ll keep this top part brief, as an abstract sharing our top three observations of leading fund managers.
Generally speaking, don’t sell your fast growing winners early.
Except when…
Selling on your way up may not be a crazy idea.
You might sell when you want to lock in DPI. Don’t sell more than 20% of your fund’s positions unless you are locking in meaningful DPI for your fund. For instance, at each point in time, something that’s greater than 0.5X, 1X, 2X, or 3X of your fund size.
You might consider selling when you’ve lost conviction. Consider selling a position when you feel the market has over-priced the actual value, or even up to 100% if you’ve lost conviction.
You might consider selling when one is growing slower than your target IRR. If companies are growing slower and even only as fast as your target IRR, consider selling if not at too much of a discount (Note: there may be some political and/or signaling issues to consider here as well. But will save the topic of signaling for another blog post).
Do note that the above are not hard and fast rules. Every decision should be made in context to other moving variables. And that the numbers below are tailored to early-stage funds.
Net TVPI Benchmarks from Years 5-15Net DPI Benchmarks from Years 5-15
Let’s go deeper…
On a cloudless Friday morning, basking in the morning glory of Los Altos, between lattes and croissants, between two nerds (or one of whom might identify as a geek more than a nerd), we pondered one question:
Everyone seems to have a financial model for when and how to invest, but part of being a fiduciary of capital is also knowing when to distribute – when to sell. When RVPI turns into DPI. And we haven’t seen many models for selling yet. At least none have surfaced publicly or privately for us. The best thought piece we’ve seen in the space has been Fred Wilson’s Taking Money “Off the Table”. At USV, they “typically seek to liquidate somewhere between 10% and 30% of our position in these pre-IPO liquidity transactions. Doing so allows us to hold onto the balance while de-risking the entire investment.”
As such, it gave birth to a thought… What if selling was more of a science?
What would that look like?
Between two Daves, it was not the Dave with sneakers and a baseball cap and with the profound disregard to healthy diets, given the fat slab of bacon in his croissan’wich, who had the answer there.
“To start off, in a concentrated portfolio of 30 investments, a fund returner is a 30x investment. For a 50-investment fund, it’s 50x. And while hitting the 0.5x DPI milestone by years 5-8, and a 2x DPI milestone by years 8-12, is the sign of a great fund, you shouldn’t think about selling much of your TVPI for DPI unless or until your TVPI is starting to exceed 2-3x.” Which seems to corroborate quite well with Chamath Palihapitiya’s findings that funds between 2010 and 2020 convert have, on average, converted about 25% of their TVPI to DPI.
“Moreover, usually you shouldn’t be selling more than 20% of the portfolio at one time (unless you’re locking in / have already locked in 3X or more DPI). You should be dollar-cost averaging – ensuring time diversity – on the way out as well. AND usually only if a company that’s UNDER-growing or OVER-valued compared to the rest of your portfolio. Say your portfolio is growing at 30% year-over-year, but an individual asset is growing slower at only 10-20% OR you believe it is overvalued, that’s when you think about taking cash off the table. Sell part (or even all) of your stake, if selling returns a meaningful DPI for the fund, and if you’re not capping too upside in exchange for locking in a floor.”
Meaningful DPI, admittedly, does mean different benchmarks for different kinds of LPs. For some, that may mean 0.25X. For others that may mean north of 0.5X or 1X.
“On the other hand, if a company is outperforming / outgrowing the rest of the portfolio, generally hold on to it and don’t sell more than 10-20% (again, unless you’re locking in meaningful DPI, or perhaps if it’s so large that it has become a concentration risk).”
I will caveat that there is great merit in its counterpart as well. Selling early is by definition capping your upside. If you believe an asset is reaching its terminal value, that’s fine, but do be aware of signaling risk as well. The latter may end up being an unintended, but self-fulfilling prophecy.
So, it begged the question: Under the assumption that funds are 15-year funds, what is meaningful DPI? TVPI? At the 5-year mark? 7.5 years in? 10 years? And 12.5 years?
The truth is the only opportunities to sell come from the best companies in your portfolio. And probably the companies, if anything, you should be holding on to. By selling early, you are capping your downside, but at the same time capping your upside on the entire portfolio. When the opportunity arises to lock in some DPI, it’s worth considering the top 3-5 positions in your fund. For instance, if your #2 company is growing quickly, you may not be capping the upside as much.
Do keep in mind that sometimes it’s hard to fully conceptualize the value of compounding. As one of my favorite LPs reminded me, if an asset is growing 35% year-over-year, the last 20% of the time produces 56% of the return. Or if an asset is growing 25% YoY, if you sell 20% earlier (assuming 12 year time horizons), you’re missing out on 45% of the upside.
As a GP, you need to figure out if you’re IRR or multiple focused. Locking in early DPI means your IRR will look great, but your overall fund multiple may suffer.
As an LP, that also means if the gains are taxable (meaning they don’t qualify for QSBS or are sold before QSBS kick in), you need to pay taxes AND find another asset that’s compounding at a similar or better rate. As Howard Marks puts it, you need to find another investment with “superior risk-adjusted prospective returns.”
And so began the search for not just moolah in da coolah, but how much moolah in da coolah is good moolah in da coolah? And how much is great?
Net TVPI Benchmarks from Years 5-15Net DPI Benchmarks from Years 5-15
Some caveats
Of course, if you’ve been around the block for a minute, you know that no numbers can be held in isolation to others. No facts, no data points alienated from the rest.
Some reasons why early DPI may not hold as much weight:
Early acqui-hires. Usually not a meaningful DPI and a small, small fraction of the fund.
There’s a possibility this may be the case for some 2020-2021 vintages, as a meaningful proportion of their portfolio companies exit small but early.
In other words, DPI is constructed of small, but many exits, rather than a meaningful few exits.
TVPI is less than 2-3x of DPI, only a few years into the fund. In other words, their overall portfolio may not be doing too hot. Obviously, the later the fund is to its term, the more TVPI and DPI are alike.
As a believer in the power law, if on average it takes an outlier 8 years to emerge AND the small percentage of winners in the portfolio drive your return, your DPI will look dramatically different in year 5 versus 10. For pre-seed and seed funds, it’s fair to assume half (or more) companies go to zero within the first 3-5 years. And in 10 years, more than 80% of your portfolio value comes from less than 20% of your companies. Hell, it might even be 90% of your portfolio value comes from 10% of your companies. In other words, the power law.
GPs invested in good quality businesses. Some businesses may not receive markups, but may be profitable already, or growing consistently year-over-year that they don’t need to raise another round any time soon.
Additionally, if you haven’t been in the investing game for long, persistence of track record, duration, and TVPI may matter more in your pitch. If you’ve been around the block, IRR and DPI will matter more.
As the great Charlie Munger once said, “selling for market-timing purposes actually gives an investor two ways to be wrong: the decline may or may not occur, and if it does, you’ll have to figure out when the time is right to go back in.” For private market investors, unless you can buy secondaries, you’ll never have a time to go back in until the public offering. As such, it is a one-way door decision.
Some LPs are going to boast better portfolios, and we do admit there will be a few with portfolios better than the above “benchmarks.” And if so, that’s a reason to be proud. In terms of weighting, as a proponent of the power law, there is a high likelihood that we’ve underestimated the percent of crap and meh investments, and overestimated the percent of great investments in an LP’s portfolio. That said, that does leave room for epic fund investments that are outliers by definition.
We do admit that, really, any attempt to create a reference point for fund data before results speak for themselves is going to be met with disagreement. But we also understand that it is in the discourse, will we find ourselves inching closer to something that will help us sleep better at night.
One more caveat for angels… The truth is as an angel, none of the above really matter all that much. You’re not a fiduciary of anyone else’s capital. And your time horizons most likely look different than a fund’s. It’s all yours. So it’s not about capping your downside, but more so about capping your regret. In other words, a regret minimization framework (aka, “spouse regret/yelling minimization insurance”).
That will be so unique to you that there is no amount of cajoling that we could do here to tell you otherwise. And that your liquidity timelines are only really constrained by your own liquidity demands.. For instance, buying a new home, sending kids to college, or taking care of your parents (or YOU!) in their old age.
But I do think the above is a useful exercise to think through selling if you had a fund. You would probably break it down more from a bottoms up perspective. What is your average check size? Do you plan to have a concentrated portfolio of sub-30 investments? Or more? Do you plan to follow on? How much if so? And that is your fund size.
In closing
Returning above a 3x DPI is tough. Don’t take our words for it. Even looking at the data, only 12.5% of funds return over a 3x DPI. And only 2.5% return three times their capital back on more than 2 separate funds.
In the power law game we play, as Michael Mauboussin once said, “A lesson inherent in any probabilistic exercise: the frequency of correctness does not matter; it is the magnitude of correctness that matters.” Most will return zero, or as Jake Kupperman points out: More than 50%.
But it’s in the outliers that return meaningful DPI, not the rest. Not the acqui-hire nor really that liquidation preference on that small acquisition.
At the end of the day, the goal isn’t for any of the above to be anyone’s Bible, but that it’d start a conversation about how people look at early returns. If there is any new data points that are brought up as a result of this blogpost, I’ll do my best to update this thread post-publication.
Big thank you to Dave McClure for inspiring and collaborating on this piece, and to Eric Woo and all our LP friends who’ve helped with the many revisions, sharing data, edits, language and more. Note: Many of our LP friends chose to stay anonymous but have been super helpful in putting this together.
Footnotes
For the purpose of this piece, we know that “good” and “great”, in fact all of the superlative adjectives, are amorphous goalposts. And those words may mean different things to different people. This blogpost isn’t meant to establish a universal truth, but rather serve as a useful reference point for both LPs, looking for “benchmarking” data, and GPs to know where they stand. For the latter, if your metrics do fall in the “good” to “great” range, they’re definitely worth bragging about.
And so with that long preamble, in the piece above, we defined “good” as top quartile, and “great” as top decile. “Good” as a number on its own, enough for an LP to engage in a conversation with you. And “great” as a number that’ll make LPs running to your doorstep. Or at least to the best of our portfolios, leveraging both publicly reported and polled numbers as well as our own.
Our numbers above are also our best attempt in predicting steady state returns, divorcing ourselves from the bull rush of the last 3-5 vintage years. As such, we understand there are some LPs that prefer to do vintage benchmarking, as opposed to steady state benchmarking. And this blogpost, while it has touched on it, did not focus on the former’s numbers.
EDIT (Aug 18, 2023): Have gotten a few questions about where’s the data coming from. The above numbers in the Net DPI and Net TVPI charts are benchmarks the LPs and I agreed on after looking into our own anecdotal portfolios (some spanning 20+ years of data), as well as referencing Cambridge data. These numbers are not the end-all-be-all, and your mileage as an LP may very much vary depending on your portfolio construction. But rather than be the Bible of DPI/TVPI metrics, the purpose of the above is give rough reference points (in reference to our own portfolios + public data) for those who don’t have any reference points.
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.
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.
There was a fascinating episode on the Tim Ferriss Show recently, where we get the inside baseball on how David Maisel, founder of Marvel Studios, raised half a billion on a promise for a company who’s public market cap at the time was only a fifth of a billion. Naturally, not only was he against a lot of headwind externally, but internally as well. According to the board at the time, they would only greenlight the idea of producing their own films (as opposed to licensing their IP out) if “Marvel had no risk. Not little risk, but no risk.”
On the cusp of Captain America and Thor being licensed away, David asked the board to give him six months. The “zero risk” pitch then came in the form of external funding, huge financial upside (if things worked out), market timing, and a promise.
Financial upside for Marvel
As David puts it:
“First to my board, the argument, was if we own our own studio, it means we get the full financial upside that they understood very well.” As opposed to licensing, their traditional business model. Where Marvel only got five cents on every dollar of profit. As was the case with SONY and Spiderman.
“Number two, we decide on greenlight when the movies get made that they also understood because they only sold toys really at the time, and the toys were contingent on a movie, which they then control the timing. Now when you’re doing a public company and you’re giving guidance every year, how can you give guidance if you don’t even know what movies are going to get made? And so controlling greenlight was important, full creative control.”
Moreover, the team was able to take 5% of revenues as the producer fee AND keep all non-film revenues (i.e. toys, video games, etc.). And even if four out of the five films lost capital, they’d still make $25M in revenue each. In other words, $100M in sum. Half of Marvel’s public market cap at the time. Whose cap was only based on toy sales.
Market timing
“The bond bubble of 2004 was happening,” as David shared, “so it was a time where there was loans being made that shouldn’t have been made. And a lot of people were enamored with Hollywood as they get enamored every few years.”
Zero downside
Instead of funding the studio off balance sheet, David would go out to fundraise from others. So what was the external pitch?
“Give me four at bats, and if one of them hits, then every movie’s a sequel after that.”
On top of all the above, to me, there were some interesting terms for the investment that helped sweeten the deal:
Merrill Lynch got a 3% success fee upon the $525M closing.
David got a low interest rate loan from Merrill by getting it insured by MPAC, therefore the debt became AAA debt, which “was easy to sell to pensions and easy to sell to individual investors” in case things went awry.
Now I’m not sure if this is standard Hollywood practice. But I imagine it’s not, at least back in ’03 and ’04. I’m a venture guy after all. And as one, the above is news to me.
That said, the banks David went to fundraise from were not taking equity. It was “pure debt. So very low interest rate. And the only collateral were the film rights to ten Marvel characters of which we could make for the movies.” Which, to me, ten characters sounds like a lot for a company whose business is characters. I also imagine these were characters that had some level of historical fanbase, so they weren’t random ones from the archives.
But David clarifies. “A lot of people misunderstand that they think we pledged ten of our characters as collateral. It wasn’t that at all because in the worst case scenario, it only got collected if we lost money on those first four movies. And then those six characters, we owned all the rights besides film. And if a film was ever made by the bank, whoever collected this collateral, we got the same license fee that we get if we just license it that day to a party. So there was no opportunity cost.”
And the promise
This is history now, but at the time, was a bold claim. The idea was borne out of frustration as an entertainment investor. That:
Marvel couldn’t capture a large part of enterprise value through productions with just licensing
The first movie business was horrible. Sequels, on the other hand, were a lot more predictable. So, the focus after the first movie would not be on predicting profit, but maximizing profit margins.
So David had a thought. “What if after the first movie, every movie after that was a sequel or a quasi-sequel, which required all the characters, or a lot of the characters, to show up in multiple movies?”
The idea of sequel snowballed into what we now know as the MCU — the Marvel Cinematic Universe.
Bringing it back to venture
It’s a nice corollary to raising a Fund I, where you’re also selling a promise. A world vision. A painting of the future. Nothing’s proven yet. You’re sure as hell not selling a repeatable strategy yet, and definitely not any returns. Since there’s a good chance you haven’t returned capital to LPs before.
And this is true for not just funders, but also founders. In the words of Mike Maples, “Breakthrough builders are visitors from the future, telling us what’s coming. They seem crazy in the present but they are right about the future.
“Legendary builders, therefore, must stand in the future and pull the present from the current reality to the future of their design. People living in the present usually dislike breakthrough ideas when they first hear about them. They have no context for what will be radically different in the future. So an important additional job of the builder is to persuade early like-minded people to join a new movement.”
Dissent is a luxury
The truth is loads of people will disagree with you. You’re not looking for consensus. In fact, it’s better to be wrong and alone than right and with the crowd if you’re in the venture world. Either as a founder or an emerging GP. It’s something I recently learned from the one and only Chris Douvos. If you imagine a 2×2 matrix… On one axis, you have right and wrong. On the other, you have with the crowd and alone. You want to be in the right and alone quadrant for sure. That’s where “fortune and glory” exists. It’s where alpha exists. It is how you become an outlier and achieved outsized returns.
But the prerequisite to be there is to have the guts to start in the wrong and alone quadrant. If you start from being right and in the crowd, you’re one among many. And that doesn’t give you the liberty to have independent thinking. You’re constantly trapped in noise.
It’s as Abhiraj Bhal says. “If you are a category-defining company, you will always have a TAM question, if the category is defined by somebody else, you will not have a TAM question.” You want people to question you. And as humans, we like to fit in. But to create something transcendent, external doubt is your best friend.
As such, your promise of the future must seem bizarre.
Don’t start with the product, start with your customers
When you have a promise, admittedly, the easiest way is to start engineering it right away. Without market validation. Without stress testing. Which pigeonholes a number of founders. I forgot the origination, but there’s a great line that says, “The only difference between a hallucination and a vision is that other people can see the latter.”
And in order to test that, you need to get in front of potential users and customers first. Max, someone I had the joy of working with, once wrote the below timeless tweet:
My hot take of the day:
Most aspiring startup founders who think they should learn to code would be better off learning to write well instead.
As Elizabeth once shared: “We decided that we’d start with no product. We would not build anything. And, we just started selling ads. We manually brokered deals with publishers and advertisers and took a cut in between. We got our customers by emailing people and setting up the copy and links ourselves. People would pay me through my personal PayPal account. It was only when we realized we were onto something that we started building technology to remove bottlenecks.”
On the investor side, it’s building a thesis where great investments fall into. It’s a way of looking at the world in a perspective that may seem foreign to others, but almost obvious in retrospect. The thesis should elicit the response, “Why didn’t I think of that first?” But no matter how obvious, you are the best positioned to bring the thesis to life. That doesn’t mean you need returns yet. Although good graduation rates certainly help as a leading indicator.
In that regard, it’s quite similar to how David Maisel foretold of the Universe to come. Obvious once explained, yet still met with resistance from legacy players.
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.
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.
