At a dinner earlier this week, a Fund I GP shared how she had recently hosted her first AGM (annual general meeting). Of which, she spent a few hundred dollars to plan the whole thing. She called in favors on venue. Sponsors to cover food. And the only thing I believe she spent money on were gifts for her LPs. For comparison, when I caught up with a firm with 10+ active funds, they said they spend about $2M on their annual summit.
For the uninitiated, the annual summit or AGM is typically the event VC firms hold once a year for their investors, as well as for their portfolio to recap the year and share what’s next. I won’t go too deep here, but for those curious, I wrote a post last week on this.
Naturally, I had to tip my hat off. Not only is hosting a large event like an AGM time-consuming, to minimize the damage to one’s wallet to only a few hundred is a Herculean feat. And yes, she single-handedly pulled it off. While I wasn’t there myself, A+ for executional discipline.
One of three kinds of discipline that LPs expect of GPs. What are the three?
- Entry discipline
- Exit discipline
- Executional discipline
The three E’s.
Did I force myself to find three words that start with E’s that fit? I’m glad you noticed. Originally, called it: investing discipline, exit discipline, and operational discipline. But I digress.
Let me elaborate.
Entry discipline
Entry discipline is all about what and how you invest. It’s the one GPs talk about the most. While it is important – one of the three legs of the stool, it’s not the only one that matters. Nevertheless, it’s a bet on the investor.
These include:
- Entry prices (pre-money versus post-money valuation)
- Ownership on entry
- Sourcing / picking / winning
- Due diligence process (references, legal diligence, tech diligence, operational diligence, etc.)
- Prepared mind
- Terms of investment (you’d be surprised the number of
- Pro rata rights, and drag along, and right of first refusal (ROFR)
- Information rights
- Portfolio governance (board versus board observer seats)
Exit discipline
In the words of Renaissance’s Jeff Rinvelt, “the one that wasn’t baked in for a lot of these firms was the exit manager – the ones that help you sell. […] If you don’t have it, there should be somebody that it’s their job to look at exits.”
Exit discipline is all about how you think about portfolio construction on a broader sense. And of course, how and when to exit positions. It’s the one LPs care about most in a liquidity-starved environment. It matters especially so for venture that’s known for long illiquidity periods. Still matters for buyouts and other assets, but those have shorter time horizons. When am I going to get my money back? Is there a plan? And while mileage will always vary fund to fund, are you at least primed to react when there are opportunities? Will it be consistent or will you suffer from opportunistic whiplash? It’s a bet on the fund manager. Or really in Jeff’s words, the exit manager.
These include:
- Strategy on when AND how to sell. Simply, how much upside to cap to protect your downside.
- Proactive and explicit communication on fund lifespan and extensions
- Relationships with secondary buyers
- Recycling
- Early distributions (after the recycling period)
- Enterprise value to breakeven. To 3X. To 5X.
- The exit manager, if applicable
Executional discipline
To quote the amazing Ashby Monk, “the difference between your gross return and your net return is an investment in their organization.” In other words, executional discipline is a bet on the team. Is the team uniquely positioned to scale execution? Are they incentivized in the long-term to do the right thing for both founders and LPs? How is knowledge passed down?
These include:
- Fees on capital committed versus capital deployed
- Fund expenses (travel, meals, hotels, fund admin, legal, accounting, etc.)
- Talent
- Events, AGMs, brand-building exercises
- Content engine, if one pays for such
- GP salaries
- Culture (deal attribution, short and long-term incentive plans, manifestos, succession planning, promotions, vesting schedules, etc.)
- Carry
- Reporting (Monthly, quarterly, or annually. It doesn’t matter which, just stick to it. Be consistent.)
- Valuation Policy / Marks (FYI, SAFEs and convertible notes are not marks. But also, if a portfolio company is overvalued, what’s your valuation policy?)
- LP Advisory Committee (LPAC)
- LP Agreement (LPA) / Subscription Agreement
- Capital calls
- Cybersecurity policy / Information policy (Who gets access to what information?)
- Compliance / PR
In closing
Obviously, as your track record and returns grow and speak for themselves, you accumulate a new type of currency in the karmic bank account: trust. You should always never exceed your means to pay. That your credit balance never exceeds your debit, but you undeniably have a greater credit line to operate the institution.
To simplify…
| Entry Discipline | Exit Discipline | Executional Discipline | |
| The bet | The bet on the investor | The bet on the fund manager | The bet on the team |
Note that for an emerging fund, these three disciplines are expected of the same individual. In many ways, much harder than if you had a fully staffed team.
Photo by Ales Krivec on Unsplash
