Tag: fundraising

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(Not) Relationship Advice

relationships, biking

Earlier this year, when catching up with a friend and talking about love, he shared his greatest relationship advice. “You want to marry someone who believes the world happens because of them, not to them.” And it really stuck with me. Both he and I are people who have big dreams. That in order to make our dreams happen we need every oar rowing in the same direction. That includes the people we surround ourselves with. More than anyone else, our romantic partner is likely the one we spend the MOST time with. But that in itself is a slight digression.

In a somewhat parallel sequence of events, at the end of last year, I had the opportunity to join a much, much larger shop. And while I ended up choosing not to join, the primary question I was asking myself was: If I were successful here, would I be successful in spite or because of the institution? The truth was from an outsider’s perspective, maybe even personally, it’d be really hard to tell.

Now why do I share the above? And where the hell am I going with all of this? What does love have to do with career opportunities?

So… this won’t be my most graceful transition between thoughts, but in my head, they all orbit the same genre.

One of the questions I used to ask LPs during my time in investor relations was: “What was the last investment you made that didn’t work out? Without naming names, what happened?”

And there are two reasons I ask that:

  1. Oftentimes, knowing what an LP doesn’t or won’t ever invest in again is more telling than asking them what they do invest in. LPs are, by definition, generalist. And under that premise, they technically invest in “everything,” so you’ll end up getting very broad answers, especially if they cover more than one asset class.
  2. Do they describe an investment that didn’t work out with active or passive verbs? Did it happen to them? Or do they own up/exhibit agency over their own decisions? Are they arbiters of their own destiny? “I made this investment decision, learned, and this is what I won’t do in the future. Or will still continue to do.” is different from… “This mishap happened to me. How could I have known? It is what it is. It’s not my fault. It was out of my control. It was someone else’s decision.”

For the latter point, people who don’t seem to be able to own up to the decision will likely not be your greatest champions if you’re an emerging manager. If at all. To them, life happens to them. They can’t control it. They have a narrative they keep telling themselves that they have no power. Some might be true. But these folks rarely stick their neck out for you.

By default, most emerging managers look less than pretty. A million reasons (most of which likely true) of what could go wrong. And it’s actually in the best interest of a capital allocator’s career and income that they stick their neck out for risky bets. Many institutions don’t compensate their team based on outlier performance. So incentives won’t be aligned. But to borrow an adage of Jobs, “the people who are crazy enough to think they can change the world, are the ones who do.” And at the very minimum, they have to believe they can change their own world.

When things are non-obvious—from a returns perspective or strategy or anything else—you need people who can and will invest courageously and own that decision.

Photo by Everton Vila on Unsplash

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.

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“Venture is a Who Business, Not a What Business” | JD Montgomery | Superclusters | S7E1

jd montgomery

“One thing that is unique to private equity and venture capital is persistence is a little easier because of the brand. ‘They did good deals, so therefore, the good deals come to find you.’ If you were in a long-only private equity shop or hedge fund, Amazon is not going to come find you because you invested in Shopify.” — JD Montgomery

JD Montgomery leads the Family Office division at Canterbury Consulting and is a seasoned advisor with nearly four decades of experience serving prominent families with a focus on strategy, organization and measurement. Based in Newport Beach, he serves a select group of multi-generational families and helps them navigate the complexities of wealth, purpose, and legacy. Mr. Montgomery partners with his clients to help them optimize the allocation of their resources across generations. Over the years, Mr. Montgomery has developed a deep network of relationships in the venture capital industry. He has helped his clients gain meaningful exposure to venture funds and direct investments and develop relationships with leading innovators and investors globally. He is a Managing Director, shareholder, and board member at Canterbury Consulting. He graduated from Stanford University and holds the Chartered Alternative Investment Analyst (CAIA) designation.

You can find JD on his socials here:

LinkedIn: ⁠https://www.linkedin.com/in/jd-montgomery-6161341b/⁠

Listen to the episode on Apple Podcasts and Spotify. You can also watch the episode on YouTube here.

OUTLINE:

[00:00] Intro
[02:18] The “some day” exercise
[11:12] Why does JD do “some day” every 6 months?
[12:33] JD’s life line
[16:44] When JD is 85 years old…
[18:05] JD’s relationship with fatherhood despite the trauma
[22:40] Annual dad report cards
[25:33] Intentionality with GPs
[28:41] How to avoid one-hit wonders
[33:43] How to transfer self-esteem
[36:05] How do you get GPs off of their talk track?
[37:36] Non-obvious things JD looks for in GPs
[41:43] Is selling 0.2X DPI in the first 4 years meaningful?
[44:27] Should you recycle capital or deploy out of the next fund?
[46:34] Why did JD choose to work with families?
[48:07] “Never eat alone”
[51:34] How does JD think about time allocation?
[55:06] How many new GPs does JD meet with?
[59:07] How did JD pass on then back Founders Fund?
[1:03:22] The difference between unexplored gold veins and rotting trash
[1:08:13] Mayan Mocha at Austin’s Picnik
[1:08:58] JD’s secret street taco recipe
[1:11:09] JD’s reminder that we’re still in the good ol’ days
[1:13:20] Post-credit scene: No garlic and onions

SELECT LINKS FROM THIS EPISODE:

SELECT QUOTES FROM THIS EPISODE:

“I don’t have a mentor per se. My mentor is hundreds, probably thousands of people—I’m sure thousands—people that I’ve met where I try to learn just the amazing talent that person has and I smush it with the next person that I meet that might be most kind person that I meet or the most organized. So it’s this blend of a lot of people that really becomes the mentor.” — JD Montgomery

“DOD – dear old dad.” — JD Montgomery

“Kids grow up like trees and saplings. And a sapling needs a guiding post to hold them up when it’s windy.” — JD Montgomery

“One of the other questions I will ask is: ‘Tell me about the hardest thing you’ve ever done in your life.” — JD Montgomery

“To whom much is given, much is expected.” — JD Montgomery

“In estate planning, you can transfer money, but you can’t transfer self-esteem. Self-esteem is gained by going through the school of hard knocks and doing things and relying on yourself.” — JD Montgomery

“One thing that is unique to private equity and venture capital is persistence is a little easier because of the brand. ‘They did good deals, so therefore, the good deals come to find you.’ If you were in a long-only private equity shop or hedge fund, Amazon is not going to come find you because you invested in Shopify.” — JD Montgomery

“If they’re passionate about something—if they want to leave the world just a little different—their ding in the universe—and they want to give back, money doesn’t ruin them.” — JD Montgomery quoting a North Carolina professor

“I am not in a ‘what’ business; I’m in a ‘who’ business.” — JD Montgomery

“Gross IRR; gross performance. I don’t care. I care about net. It’s okay to show gross and then net. I prefer net. But if you show gross only, it’s just gross.” — JD Montgomery

If you somehow made it to the bottom of these show notes, I’m also trying a new experiment where I write my reactions to the episode on my second blog, Superclusters After Hours. For JD’s episode, you can find my reactions here.

Follow David Zhou for more Superclusters content:
For podcast show notes: https://cupofzhou.com/superclusters
Follow David Zhou’s blog: https://cupofzhou.com
Follow Superclusters on Twitter: https://twitter.com/SuperclustersLP
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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.

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The Texture of a Thesis

Meriam-Webster defines texture as “the visual or tactile surface characteristics and appearance of something” or “the disposition or manner of union of the particles of a body or substance.”

A more interesting definition, at least on the tactile front, might be the resistance you feel when your skin brushes against a substance. The friction you feel. The subsequent expressions of rough or smooth follow the amount of friction you experience.

I was reading Scott Belsky’s latest blogpost. In which, he wrote the following:

“The more you remember, the more you will feel you have lived. I can’t vividly remember the details of more than a couple beach vacations, because they all blend together. But I vividly remember a night out in Tokyo at a tiny bar with my friend Joe, the first time I skinned up a mountain in Colorado, the longest run I ever took in the rolling hills of Tuscany, and getting lost in the streets of Kyoto with my daughter. The experiences I remember most are those that had texture — some sort of surprise or hardship that implanted them in my brain. These experiences create “core memories” that remain distinct and persistent, no technology required. My thesis on the future of humanity is that we will optimize for more of the experiences we’ll never forget. We will seek activities with texture to create memories that grip. And when we look back, the more of these textured memories we have, the longer we will feel we have lived.”

In a similar way, the ‘texture’ of life includes the moments we most struggled. And in the physical and metaphoric definition of ‘texture,’ leaves us scar tissue that protect our body from future similar experiences. It’s hard to recall the vivid details of life when it was all smooth sailing, but near impossible to forget our greatest character-building moments.

I’m a big believer that theses are the same. A product of our past experiences. And the restrictions we place on ourselves are a function of that. So regardless if an investment thesis is specialist or generalist, what I find more interesting are areas a GP chooses not to invest in, which include what they have never invested in, or have and will never again. Even more interestingly, assuming one only had the chance to interpret the “visual” nature of the thesis, what are the types of investments most people would think falls under a GP’s thesis, but a GP still will not invest in? The latter of which is the “tactile” nature of a thesis. The contact sport. That unless you interact directly with the GP, it is hard to tell.

Oftentimes, the GP may have more boundaries for themselves than we as LPs place on them. And that is always worth digging into.

The texture of the thesis.

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.

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“How do I prove to an LP that I have good deal flow?”

So, this is the first blogpost I’m cross-posting from my brand new Substack, Superclusters After Hours. Don’t worry, I’ll still write here weekly. This blog has always started as a personal blog. I write about what I want to write about on a weekly basis. Sometimes, it’s about venture. Other times, it’s about food, adventure, and random things I think about. The goal of the new blog is to become the primary catalog and archive for ephemeral LP content that I post on LinkedIn, with event invites whenever I do them. Events, for those of you reading this blog and know me, I have almost never publicized them before or after the event. And it’ll continue to stay that way. But I’m going to start playing around with the idea of doing Superclusters-only webinars with a very strict rule of confidentiality. TBD.

Here’s a question I got from a GP recently, which to be fair, took me much longer than I initially intended to respond to.

To the GP who sent this to me, and I know you’re reading this, thank you. It’s a great question. And one I’ve heard frustrate many a good GP out there.

So I’m going to include below what I wrote to that GP — word for word. So apologizing ahead of time for typos and grammatical errors.

Ok, this is an awesome question! Took some time here so I could better process my answer for you. Apologize for the delay and ramble ahead of time.

So I think there are 2 questions here: (a) how do you stand out as a GP who actually has deal flow when everyone claims they do, and (b) in a broader scope, how do LPs diligence deal flow?

I’ll start with the former.

(a) How can you prove to LPs you have deal flow that’s different/better than others?

So first off, most people say the same thing: “I get deal flow from founders in my network and co-investors.” But if everyone says that than even if it’s true, how does yours look any different? The truth is most LPs don’t know either. And in some ways, it might be easier to guide LPs how to think, that not only helps them diligence your fund, but also makes them a better LP, period. Keep in mind, most LPs cover a wide variety of asset classes and venture, much less emerging managers, is the smallest of the smallest chunk. And so they don’t have the incentive or the experience to really dedicate all their time to try to figure out how to better underwrite venture.

It’s similar to a question a friend of mine recently asked me. My friend is someone who eats to live (as opposed to lives to eat. Yes, those people exist in the world). And recently he found himself in love with someone who loves to eat, and by function of that, lives to eat. And so he asked me, despite having eaten at a bunch of restaurants, “how do I know which fine dining restaurant to bring his girlfriend to for their 6-month anniversary?” And I gave him a whole list of things I look for when it comes to picking restaurants. For instance, reading Google and Yelp reviews, but specifically the 3 and 4-star ones, not the 5- or 1-star ones because they’re so biased. And on top of that, I gave him recs of date-ish things to do pre- and post-dinner as well based on proximity to the restaurant. I also told him in the reservation to ask for a 10-15 minute kitchen tour after the dinner as an extra special experience. And after giving him all of that, he stares blankly at me. Not because he didn’t hear or understand what I told him, but because, really, he was just looking for a name. One name. He would then book it, and move on with his life. Because food, for him, was and is not his focus area. He had other “more important” things to focus on in his life and in the relationship.

Similarly, most LPs are the same when they look at venture. They do it because they need to think about total portfolio allocation or the David Swenson model, but they don’t do it because they love it or that they believe in it. And so they need to know a name, and that’s all they need.

So to get off my preamble, assuming that an LP has committed in their mind to spend time and do the work in emerging manager land, then you proceed with the next step. And unfortunately, most won’t. And that’s okay. They’re just not the right fit for you now.

So, the next step is really to guide them. One thing I’ve found to be helpful (if you have it) is to take your strongest few co-investors that you think you have the best relationship with, and ask the LP, “Let’s take X firm. What are the best investments they made in the last 12 months, say by revenue growth or headcount growth? And I will tell you if I saw them before they made their investment and who shared it with me.”

Conversely, you should look at who else you know well in their existing portfolio, and have them vouch for you and the type of deals you see. Also potentially more importantly, the kind of person you are. The strongest co-signs are often GPs in their existing portfolio and institutional LPs that specialize in venture that they’re really close to.

Another thing I’ve seen a GP do (paraphrasing here): “I’m going to give you a list of folks who send me deals, short list, and I can give you a longer one if you’d like. And I haven’t told them you’re going to call, so please use your best judgment when asking for their time. But ask them how many other VCs they passed the last 5 deals they shared with VCs to? If they’re doing their job right, they’ll likely pass to more than one. But see if my name comes up. If it doesn’t, you have your answer. If it does, you have your answer.”

Going a step further, and I don’t think I’ve seen any GP do this yet, but I feel like it should be more of a thing: Take all the deals you’ve gotten from your “network” (i.e. founders, investors, etc), and segment them by, who sent you a deal because:

  • You co-invested with them in the past
  • You invested in them
  • You didn’t invest in them (compliment to an investor to get strong deal flow from someone they passed on) – anti-portfolio, but keep in mind this only matters, if the people you receive it from are successful founders in the eyes of an LP, maybe you asterisk these
  • You had no prior economic relationship with them
  • You used to work with them
  • They’re a fan of you/your content/etc
  • I’m sure there are other segmentations, but you get the gist.

And in addition to that, when you pass on a deal that someone refers, categorize the deal into why it’s a pass:

  • Not a strong founder
  • Too expensive, but good founder
  • Good founder, but not in sector/thesis
  • Not raising at the time

And all the above you would show to an investor and I think should be a good snapshot as to the quality of your deals. Then if you’re comfortable with them, challenge them to try the same exercise with other investors. Part of proving something to an LP is to help them become a better investor, period. Whether they invest or not.

(b) How do LPs diligence deal flow?

The simple answer is: they do references. In terms of how many, I’ve heard everything from 3 to 40. The highest end being Cendana. Most institutions

For those that do 5 or less, primarily either use an oCIO/RIA (i.e. Cambridge, Stepstone, Hamilton Lane, some kind of MFO, etc.) or they primarily bet on firms that are hard to get but also won’t get them fired, largely because they don’t just have the time/resources/team members to specifically underwrite emerging managers in venture. Because of the optimization of “I need to see ‘everything’” and I don’t have the time to go deep and assuming they choose to do (in some parts) their own work, they:

(i) talk to a lot of spinouts ‘cause easier to reference and draft a memo to get buy in

(ii) talk on stage at conferences with the perception that they are open for business, which they technically are, but very selective

(iii) have you go through really long ODDs and DDQs in front of a (large) panel of stakeholders and decision makers in the organization. Ranges for 3 to 20-something people all listening to you answering questions. At that point, it’s your word against your word, but a committee will nitpick on everything. The upside is that it’s easier to share something you do that you’re 1 in 5 or 1 in 10 who do (as opposed to FoFs and venture-focused MFOs or institutions who need you to be 1 in 100 or 1 in 1000). The downside is you need to appeal to a larger group of people, and it takes more time outside of meetings (up to 350 question ODD).

But I digress. For the purpose of your question of your question and what I believe your frustration might be, I’m going to focus on diligencing deal flow when you’re not in the room. Assuming it’s an LP who is actually intentional about diligence AND is open-minded enough to not bring too many of their own biases in…

  • On-list
    • Founders: sticking to the facts. How did you meet the GP? What did you talk about in the first meeting? How long did they take before they committed? What questions were asked? Did other VCs ask the same questions? How competitive was the round? If you offered any special terms, why and who else did you offer it to? Did they all take it? Have you introed any other founders or people to the GP? Has the GP provided you value post-investment?
    • Co-investors: Who gives you the best quality of deals? Intro to meeting ratio? Meeting to diligence ratio? Meeting to commitment ratio? How does this GP stack rank against other relationships/other verticals? Did the emerging GP intro you to the deal you’re co-investors in?
    • LPs: How many other firms of a similar strategy did you talk to? What were the sourcing strategies for the other firms? Compare and contrast.
    • Former employers/misc: deal flow isn’t really diligenced here. The best thing these folks can attest to is your character + network.
  • Off-list (a lot of off-list is done with people who, in the words of an LP, “owe you [the LP] more favors than they owe the GP”)
    • Founders: Rank your favorite investors on the cap table. Who are your top 3? Why? If you were to start a new co, who would you take with you again?
    • Co-investors: How much signal is a deal if that GP sends it to you? Compare with other GPs. Why?
    • LPs: Have you gotten co-investments from the GP? How is their level of communication post-investment?
    • Others: Same as above.

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.

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Nemawashi

early morning, nemawashi

I learned a new word today. Nemawashi.

The Japanese word for the business practice of building consensus and hearing people’s opinion before the decision or change is formally proposed.

And I don’t think I know the English parallel to that.

I’ve always told the GPs and founders I work with/have invested in that they should involve their investors in major decisions before they’re proposed and discussed. That no board meeting or LPAC (LP advisory committee) topics should ever be a surprise. It also shows that you’re not talking at people and you’re trying to involve them as a true partner for your business. Both LPs and VCs (to founders) highly prefer that. Conversations should never be out of convenience, but they should feel intentional. You also don’t have to be perfect, neither should you pretend to be with the people who’ve chosen to be with you long-term. Just as you shouldn’t hide any trauma, sentiment, and harbored feelings from your romantic partner and family.

The quarterly board meeting and the LPAC meeting are merely formalities. You should be able to trust your investors outside of those structured events. You may not need to bring up certain topics because it’s not written in the term sheet or limited partner agreement, but that doesn’t mean you shouldn’t. Partner struggles. Off-thesis investment opportunities. Major hires. Or layoffs.

There are a lot of VCs and LPs who would love to be true partners with you, but sometimes they don’t know how to help unless you ask for help before you make the decision. Have the conversation early on about how they would like to be involved in your business. And for those who do, go to them before you propose a decision or change.

Now I know there’s a word for it.

Photo by Jasper Graetsch on Unsplash

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.

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DGQ 26: Which Slide in my Deck Stood Out the Most?

slide

One of my most used lines in my diction is: “Your mileage may vary.”

Maybe because of what I’ve written historically about. Maybe ’cause of my previous life in investor relations. Or maybe, it’s because of the interesting node I sit at in the venture ecosystem. I often get asked by GPs and founders alike for fundraising advice. Now before you come to any conclusions, I don’t have a silver bullet. I’m not even sure if my advice when it comes to fundraising is any good. While I’m lucky to have heard back from a number of people I’ve shared my thoughts with on the result of their fundraise after employing my “advice,” I’m still not completely sure how much of it was the fundraiser themselves and how much of it was the advice. And how much the color of the jersey matters.

And so when I share what I’ve seen or done, I always caveat with that first line. That said, what I think is more useful than any advice I could give pre-mortem is listening to the feedback of the market. The people you’re pitching to. When someone says no, why do they say no? When someone says yes, why do they say yes?

Inspired by a conversation I had the previous week at a summit, getting feedback from someone who passed is tough. Through the archives of fundraising, you’re more likely to get no’s than yes’s. And when you do, do you know why? Very rarely do you get much feedback. Investors (LPs and VCs) are either too busy or have too much to go through to give feedback as intimately as you probably like. And so I’ve always found it useful to make it easy for people to give feedback. Naturally, it’s never guaranteed you’ll get a response, but usually, the below question I like to ask reaches less deaf ears than “Can you give me feedback?”

I know you’re busy, and you simply don’t have the time to give every pass a share of feedback. But if I could ask for 30 seconds of your time (no more than that), which number slide on my deck did you most notice (good or bad)?

Or… was there a particular slide in my deck that piqued your interest the most that led you to schedule our initial meeting?

The goal of this question is to triangulate attention and mindshare. When you get the answer, then you can come to your own (hopefully intellectually honest) conclusion about whether the message shared on that slide is strong or weak. Controversial or not.

Moreover, you’re not overstaying your welcome. The advice and feedback you’re asking for in pointed and doesn’t consume a lot of time for the other party to answer (yet will feel to them as if they’re doing you a favor and/or being helpful).

Only once you know why people say no can you actually iterate on the pitch. Of course, there are many different ways to ask for feedback, and… your mileage may vary. Usual fundraising advice gets you through the first 10 pitch meetings. After that, you need to course-correct based on the feedback you get back.

One thing I will note is that in the age of agentic venture firms and tools that can be built within hours that cover every stretch of the imagination. One thing an LP told me that a GP told them was that some founders are getting smart. Preparing two decks for investors: one for the human eye, the other for the agentic audience. The latter with more appendices than the former. I imagine that it’s only a matter of time before VCs do the same to LPs as LPs are building agentic deck readers. In that sense, asking for deck feedback may not hold as much weight as it used to. Who knows?

Nevertheless, if there’s one takeaway from this blogpost, it’s that if you want help, if you want feedback, make it specific, low friction, and direct.

The DGQ series is a series dedicated to my process of question discovery and execution. When curiosity is the why, DGQ is the how. It’s an inside scoop of what goes on in my noggin’. My hope is that it offers some illumination to you, my readers, so you can tackle the world and build relationships with my best tools at your disposal. It also happens to stand for damn good questions, or dumb and garbled questions. I’ll let you decide which it falls under.

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.

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AI-Native VC Firms

wall e, ai, robot

There’s been this term that’s been thrown around as of late. By GPs. Funnily enough, not by a single LP so far. The “AI-native” venture firm.

Somehow everyone seems to think they’re the only ones doing so. But they’re not. While not everyone approaches it in the same way—and the definitions do get muddled a little—there is a growing audience of GPs building a firm leveraging agentic tools.

So, inspired by a recent conversation with my man Arkady, here’s me offering my definition of what an AI-native VC firm is. It’s a set of workflows that even the large incumbents cannot replicate by adding more people to the problem, despite the fees they draw. It’s where technology is at the core of the firm, as opposed to humans. It’s where experience actually becomes an inhibitor to investment innovation. Call it the legacy tax. Or experience tax. Or as Bret Taylor puts it, the strategy tax.

In a recent Uncapped episode, Sierra‘s Bret Taylor put it this way when speaking of SaaS business models. “In these moments of big platform shifts, what were your strengths can become weaknesses. […] You start to say that ‘Well, I don’t want to just start from scratch. We’ve got all these assets. So how do we do it in a way that takes advantage of all of our assets.’ And so all of a sudden, you’re like, ‘Let’s not just build a great product. Let’s transition from this product to that product.’ […] ‘That’s our strength, we should play to our strength.’ And you start to basically make all these decisions that sound sound very clever because you’re playing to your strengths. And in practice, if the technology wave is bigger than the category, which I think the web was as an example, you end up chipping away at doing a pure play value proposition.

“It can also work with business models though. In that time, you have perpetual license software and moving to software-as-a-service, that’s a huge change for a business to make. For your customers, that goes from being CapEx to OpEx. For you as a company, it changes ratable revenue. Shantanu did this at Adobe. Very few companies can make that transition. You have to sell it differently. You have to compensate salespeople differently. Revenue recognition is different. So you have the product strategy tax. You have the business model strategy tax. You have even the incentives of sales people—there’s a strategy tax. […] All the advantages that you had, all of a sudden, become anchors that are holding you back from doing the right thing.”

But I’m probably not the only one that can see the transposition of venture models on this analogy of SaaS models. I’ve also been in a few rooms where LPs are starting to slow to halt their pacing into investing in AI companies and funds. If so many of these products can be built overnight with Opus/Cowork, Codex, Cursor, Replit, Base44, Emergent, OpenClaw (and all of its clones in the last 2 weeks) and the list goes on, how many of these application layer AI companies will be stripped of their value almost immediately. And likely, in one month’s time from writing this piece (if not within the next few weeks), the list may already be obsolete.

In fact, I was catching with my LP friend (who’s not technical) last week and he used one of the above tools to build a portfolio management tool in two hours that has more functionality than what I’ve seen from companies trying to solve the exact same problem who’ve raised up to 9-figures. And I wish I could say I was joking. He told me, “Tools for us have historically been limited by the marriage of domain expertise and technical expertise. Most of us didn’t have both. But with these tools, they solve the technical expertise part, which empowers domain experts to build their own tools. So why bother paying for any other tool that doesn’t have the same depth of data that I’ve accumulated across decades?”

Henry Ford has that line many of you are probably aware of, “If I had asked people what they wanted, they would have said faster horses.” Most investors—big and small, multi-stage and emerging, generalist and specialist, solo GP or partnerships—are building faster horses.

So an AI-native firm has to reimagine the way the venture business is done. That isn’t an AI-written memo. That’s not just an agent strapped onto a data scraper. Assume everyone at some point can discover and find every company out there. Today’s firms who claim being AI-native (in my anecdotal experience) are highly focused on sourcing. What pools of data aren’t actively being collected now that software can relentless dig into. Today’s firms aided by AI are leveraging tools to make more informed investment decisions. The picking. It still requires, for the most part, a human in the mix to make the final call. There are very, very few, arguably no one, truly leveraging AI nativity to win deals.

In venture, there used to be the classic question VCs would often ask founders: “What’s stopping Google from what you’re doing?” Now it’s “Why can’t OpenAI or Anthropic just do what you do?” Analogously, why can’t a16z or GC do what you do? Historically, the answer, if there is a good one, is tied down to:

  • Business model and portfolio construction, which is still a valid point if you plan to stay as a first check purist.
  • Or, it’s come down to the person. You have lived experience that no one else does in cybersecurity or leading healthcare systems. You have privileged relationships no one else has. You’ve built communities that are centered around you as the central node. It’s usually been a “people” answer.

But with AI-native firms, the answer must be technological. Even if large firms were empowered with the idea, why will they still fail in the technological implementation of it? Why can’t these large multi-stage funds:

  • … “see” the volume you do? Are you pulling data from non-obvious hubs or non-public datasets? How defensible is it in the longer term?
  • underwrite deals at an earlier stage like you do? Are you doing diligence at scale? How do you get the “truth” from sources that other firms powered primarily by human capital cannot?
  • provide the portfolio value (at scale) like you do? Do you give your portfolio companies access to the same systems you’ve built? Can they leverage your tools to empower their customers and/or talent?
  • provide the same liquidity opportunities to LPs at a predictable pace like you can? Not sure if agentic software will be good enough here for now, given how much humans themselves are still figuring this out. But a goalpost for some visible future.
  • provide their co-investors with the same value as you can? This one might be hard. There’s always the balance of what is unique to you versus unique to others. The more you share, potentially, the less of an edge you’ll have. But my stance has always been, if access to certain analyses or information will be inevitable at some point, it’s better to be the rising tide that raises all ships than the last drop of rainwater in the ocean.
  • provide LPs with the same depth and/or breadth of value like you do? This last one is probably not something any AI-native firm I’ve talked to is focused on, but given that all venture firms are marketplaces at the end of the day, answering this question would be extremely powerful.

I’m not saying that’s the only way to do business. That’s not the only way to invest. I’m confident that even when GPT 15.0 and “Opus” 9.4 comes out, there will still be firms that operate primarily around a core set of individuals as opposed to technologies. We have mass-produced cars, but there is still a great demand for hand-crafted luxury vehicles. The same is true for fashion and accessories. So yes, there will still be a world even if they’re not the largest players by market cap where people prefer the luxury of the human touch.

Photo by James A. Molnar on Unsplash

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.

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The Currency of Trust

Recently, I had three conversations about trust. So forgive me, but that’s the soup du jour today, as their comments are still swimming in my mind.

I spent some time with the Head of Investor Relations at a high nine-figure AUM firm. And he said something that echoed much of the reality of fundraising these days. “Fundraising is all about trust. It’s not about the performance metrics. It’s about who believes in you.”

Then, immediately after, I caught up with an LP friend, who said, “Investor relations is a wasted job title in VC. They’re glorified note takers and relationship managers. I won’t invest in any fund where I haven’t met the GP.” Only to later share how much we both admired a certain Head of IR at a large multi-stage fund.

At first glance, the irony is blinding. The funny thing is that both are equally as true. GPs have a bank account where they can deposit trust. They withdraw trust every time they make an ask. Whether it’s for capital or special terms on the term sheet or for a certain ownerships target or for a guest speaker for an event they’re hosting. Before a GP starts a firm, they need to bank a lot of trust. They should give more than they take. And to run a firm, there are three types of primary customers you need to bank trust with:

  1. Founders,
  2. Co-investors,
  3. And LPs.

You also can’t take a loan on trust (in other words, outsource trust) before you’ve deposited enough trust in your own bank account. Or else, you’ll be in debt. If you’re in too much debt (i.e. have a negative balance), your reputation takes a hit. But when you’ve banked enough trust, you can have a separately managed trust account managed by others. An IR professional who manages the trust account with LPs. A community/platform person with co-investors and talent. And so on.

Having others manage these accounts too early in the firm lifecycle means taking debt and impacting reputation. So when my buddy who’s the LPs says he doesn’t like most IR folks, it’s because before the IR person was hired, the GP didn’t bank enough trust.

And the truth is trust is built not in grand gestures and one-off deals. It’s in the small interactions. How fast do you respond? Even when you’re busy, do you make time for people important to you? Do you remember what you talked about last time? Do you close the loop on advice you get from LPs—whether you use it or not? Do you remember their answer to ‘What did you do last weekend’ 15 weekends ago? Do you follow through with what you promise—even if it’s a restaurant recommendation you mentioned in the call?

In a conversation with a Fund I GP yesterday who successfully raised his 8-figure fund in 8 weeks (and yes, part of that duration was over the holidays), he said something I really liked: “Every LP is looking for returns. That’s a given. But every LP is also looking for returns plus X. Your job during the fundraising process is to find out what X is, and it may be less obvious than you think it is.” For some, X is undoing boredom. For others, it’s the front row seat to learn. Others still, it’s the prospect of social capital that will come with making an investment. And you can’t find any of these out, if you don’t spend the time to build trust with the other party.

Photo by Marek Piwnicki on Unsplash

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.

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The Third Leg of Firm-Building

marathon, race, third leg

Five years ago, I wrote a piece about the third leg of the race. From my time as a competitive swimmer, the lesson our coach always had for us was if you’re swimming anything more than two laps, the most important part of every race is the third leg. Everyone’s tired. Everyone’s gasping for air. Yet everyone wants to win. The question is who wants it more. And by the time you get to a decently high level, everyone’s athleticism is about the same. All that matters is the mentality you have on that third segment of four of each race.

We often say, that starting a company or a fund is a marathon, not a sprint. True in a lot of ways. But also, it’s a series of sprints within a marathon.

We put out an episode last week with the amazing Ben Choi, which I really can’t stop recommending. Just because I learn something new every time I talk with Ben, and this time especially so. But that’s my own bias, and I get it. But more interestingly, he said something that I couldn’t get out of my mind since we recorded. “The first three funds—not just the first two, the first three—are that ‘working-out’ process. Most pragmatically, there’s very little performance to be seen by Fund III. So it’s actually Fund IV for us to hold up the manager as no longer emerging and now needs to earn its own place in the portfolio.” The timestamp is at 16:21 if you’re curious.

And it got me thinking… is Fund III that third leg of the race?

When most GPs raise Fund III, they’re usually four, maybe five years, out from their Fund I. And that’s assuming they started deploying as soon as they raised their fund. And within five years, not that much changes. Usually, that’s two funding rounds after your first investments. But lemons ripen early, so only a small, small subset move to Series A or B. Most have raised one or less subsequent round since the GP committed capital.

Even accounting for two funding rounds later, that’s usually too early to consider selling into the next round. And if one does (unless it’s a heavily diversified portfolio and the GP has no information rights, and somehow is so far removed from the company that no one at the company talks to the GP anymore), then there’s signaling risk. Because:

  1. No matter what portfolio strategy you run, not staying in touch with your best performing companies is a cardinal sin. Not only can you not use those companies as references (which LPs do look for), you also can’t say your deal flow increased meaningfully over time. No senior executive or early employee knows who you are. So if they leave the company and start their own, they wouldn’t pitch you. Your network doesn’t get better over time. See my gratitude essay for more depth here.
  2. Not having any information rights and/or visibility is another problem. Do the founders not trust you? Do you have major investor’s rights? How are you managing follow-on investment decision making—whether that’s through reserves or SPVs? Are the blind leading the blind?
  3. And if you do run a diversified portfolio, where optically selling early may not be as reputationally harmful to the company, you are losing out on the power law. And for a diversified portfolio, say a 50-company portfolio. You need a 50X on an individual investment to return the fund. 150X if you want to 3X the fund. As opposed to a concentrated 20-company portfolio, where you only need 20X to return the fund and 60X to 3X. As such, selling too early meaningfully caps your upside for an asset class that is one of the few power law-driven ones. As Jamie Rhode once said, “If you’re compounding at 25% for 12 years, that turns into a 14.9X. If you’re compounding at 14%, that’s a 5. And the public market which is 11% gets you a 3.5X. […] If the asset is compounding at a venture-like CAGR, don’t sell out early because you’re missing out on a huge part of that ultimate multiple. For us, we’re taxable investors. I have to go pay taxes on that asset you sold out of early and go find another asset compounding at 25%.” Taking it a step further, assuming 12-year fund cycles, and 25% IRR, “the last 20% of time produces 46% of that return.” And that’s just the last three years of a fund, much less sooner.
  4. Finally, any early DPI you do get up to Fund I t+5 years is negligible. Anything under 0.5X, and for some LPs, anything sub-1X, isn’t any more inspiring to invest in than if you had absolutely no DPI.

Yet despite all of the above, the only thing you can prove to LPs are the inputs. Not the outputs. You can prove that you invested in the same number of companies as you promised. You can prove that you’re pacing in the same manner as you promised. And you can prove that founders take the same check size and offer the same ownership to you as you promised. And that is always good. As you raise from friends and family and early believers in Fund I, Fund III’s raise usually inches towards smaller institutions, but larger checks than you likely had in Fund I.

  1. Fund-of-funds care about legibility. Logos. Outliers. Realistically, if you didn’t have any before Fund I, the likelihood of you having any while raising Fund III is slim. They need to tell a story to their LPs. A story of access and getting in on gems that no one else has heard of, but if everyone knew, they’d fight to get in.
  2. Any person you pitch to who has any string of three to four letters (or is hired to be a professional manager) attached to their name (i.e. MBA, CAIA, CFA, CPA, etc.) has a job. For many, their incentive unless their track record speaks for itself (likely not, given how long venture funds take to fully return capital) is to “not get fired for buying IBM.” Some of their year-end bonuses are attached to that. Some lack the bandwidth and the team members to fully immerse themselves in the true craft of emerging manager investing. Many times, the incentive structure is outside of their immediate hands. For every bet they make that isn’t obvious, they risk career suicide. At least within that institution.

I’m obviously generalizing. While this may be true for 90%+ of LPs who fit in these categories, there are obviously outliers. Never judge a book by its cover. But it’s often helpful to set your expectations realistically.

As such, despite not much changing from your investment side, from the eyes of most LPs, you are graduating to larger and larger LP checks. Usually because of the need to provide more proof points towards the ultimate fund strategy you would like to deploy when you’re ‘established.’ But to each new set of LPs, prior to an institutional 8-year track record, you’re still new. On top of that, as your fund size likely grows a bit in size from Fund I, to some LPs, you are drifting from your initial strategy by no longer being participatory and now leading and co-leading. You also might have added a new partner, like Ben talks about in the afore-mentioned episode. And a new strategy and a new team requires new proof points related to on-thesis investments. So, Fund III is where you begin to need to whether the storm. For some, that may start from Fund II. Altos Ventures took four years to raise their Fund II. Many others I know struggled to do the same. But if you really want to be in VC long term, this is the third leg of the race.

And this is when a lot of GPs start tapping out. Will you?

Photo by Victoire Joncheray on Unsplash

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.

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When Do You Know If You’ve Grown Up as a VC? | El Pack w/ Ben Choi | Superclusters

ben choi

Ben Choi from Next Legacy joins David on El Pack to answer your questions on how to build a venture capital fund. We bring on 3 GPs at VC funds to ask 3 different questions.

Gilgamesh Ventures’ Miguel Armaza, also host of the incredible Fintech Leaders podcast, asks Ben what is the timing of when a GP should consider raising a Fund III.

Similarly, but not the same, Strange Ventures’ Tara Tan asks when an LP backs a Fund I, how do they know that this Fund I GP will last till Fund III.

Arkane Capital’s Arkady Kulik asks how one should think about building an LP community, especially as he brings in new and different LP archetypes into Arkane’s ecosystem.

Ben manages over $3.5B investments with premier venture capital firms as well as directly in early stage startups. He brings to Next Legacy a distinguished track record spanning three decades in the technology ecosystem.

Ben’s love for technology products formed the basis for his successful venture track record, including pre-PMF investments in Marketo (acquired for $4.75B) and CourseHero (last valued at $3.6B). He previously ran product for Adobe’s Creative Cloud offerings and founded CoffeeTable, where he raised venture capital financing, built a team, and ultimately sold the company.

Ben is an alum and Board Member of the Society of Kauffman Fellows (venture capital leadership) and has also served his community on the Board of Directors for the San Francisco Chinese Culture Center, Children’s Health Council, Church of the Pioneers Foundation, and IVCF.

Ben studied Computer Science at Harvard University before Mark Zuckerberg made it cool and received his MBA from Columbia Business School. Born in Peoria, raised in San Francisco, and educated in Cambridge, Ben now lives in Los Altos with his wife, Lydia, three very active sons, and a ball python.

You can find Ben on his socials here:
X / Twitter: https://x.com/benjichoi
LinkedIn: https://www.linkedin.com/in/bchoi/

Listen to the episode on Apple Podcasts and Spotify. You can also watch the episode on YouTube here.

OUTLINE:

[00:00] Intro
[05:05] Ben’s 2025 Halloween costume
[06:44] Jensen Huang’s leather jackets
[07:24] Jensen Huang’s answer to Ben’s one question
[10:05] Enter Miguel, Gilgamesh Ventures, Fintech Leaders
[14:43] What are good signals an LP looks for before a GP raises a Fund III?
[22:35] Why does Ben say ‘established’ starts at Fund IV?
[25:08] Who’s the audience for Miguel’s podcast?
[27:52] In case you want more like this…
[28:32] Enter Tara and Strange Ventures
[32:46] How does Ben know a Fund I will become a Fund III?
[36:53] How does Ben know if a GP will want to build an enduring career?
[40:58] How does Tara share a future GP she’d like to work with to Ben?
[42:43] Marriage and divorce rates in America
[43:34] What should a Fund I do to institutionalize?
[46:28] Should you share LP updates to current or prospective LPs?
[48:57] Enter Arkady and Arkane Capital
[51:09] How does one think through LP-community fit?
[1:01:31] What’s Arkady’s favorite board game?
[1:03:08] Ben’s last piece of advice to GPs
[1:09:50] My favorite Ben moment on Superclusters

SELECT LINKS FROM THIS EPISODE:

SELECT QUOTES FROM THIS EPISODE:

“The dance of fundraising is when you do have [your thesis], the LP has to figure out is this a rationalization of the past or is it actually what happened? Was this known at the time? Because if it was, we can have some confidence in the future going forward. But if it was just a rationalization of some randomness, then it’s hard to know if Fund IV or V or VI will benefit from the same pattern.” — Ben Choi

On solo GPs bringing in future partners by Fund III… “The future unidentified partner is the largest risk that we have to decide to accept. So there actually isn’t a moment where we decide this GP is going to be around for Fund III. It’s actually the dominating risk we look at and we get there, but it’s a preponderance of other things that we need to build our conviction so high that we’re willing to take that risk.” — Ben Choi

“It’s brutal. It’s a 30-year journey. For any GP who raises a single dollar from external LPs, it’s a 30-year journey.” — Tara Tan

“I don’t think anyone goes into this business to raise capital, but your ability to raise capital is ultimately what allows you to be in this business.” — Ben Choi

On community… “Your core question is how much diversity—in the technical term of diversity—can you tolerate before you lose the sense of community.” — Ben Choi

“Most letters from a parent contain a parent’s own lost dreams disguised as good advice.” — Kurt Vonnegut

“Fundraising is a journey of finding investors who want what you have to offer; it’s not convincing somebody to do something.” — Ben Choi

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For podcast show notes: https://cupofzhou.com/superclusters
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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.

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