Not too long ago, I was catching up with the amazing Owen Willis, someone I’ve been lucky to see in action during our time at On Deck together, who now runs Opal Ventures. And there was one thing he mentioned that I cannot stop thinking about.
As a fund manager, there are things you can control. And things you cannot.
So often, many a fund manager focus on things they cannot. The market. In many ways, marks. And not enough on things, they can. Chief of which, communication. What. How. When.
Are your LPs hearing about news on you or your portfolio — good and bad — from you or from another source?
What are you seeing in the market? What is your insight into it? Why? After all, LPs pay you for your opinion.
And how frequently do you maintain an open line of communication with your LPs? Do you share everything? Or only the good? Do you miss regular updates because of how busy you get?
To nosedive a level deeper, as a GP, what are your most powerful tools of communication with LPs? Not to lead the witness, but you’ve probably figured it out. LP updates. Many GPs I meet tend to only have one type. At best one and a half.
There’s the update GPs send your existing LPs. But they also understand the value of prospective LPs, so they end up sending the exact same to prospects. Maybe with some numbers redacted (if it includes sensitive information on the portfolio). Most of the time, that’s it. But really, it’s helpful to think about existing and prospects as two different audiences. The former will naturally be disposed to support. The latter is still deciding if they want to support. They have yet to be converted.
As such, instead of one, there should be two types of LP updates. To make it simpler, one is for “customer success.” The other is for “sales and BD.”
The “customer success” update
There’s a lot of content on this front already, so I’ll spare you the extra verbiage here. But if you want a place to start, I’d recommend the below first:
But to provide a brief summary (plus, a snazzle dazzle of the Cup of Zhou perspective), typical LP updates I see have:
The Abstract / TL;DR / What to know if you only had 2 minutes
Performance (TVPI, DPI, IRR, new investments, % deployed, % left, % capital called, and (if so) did you preemptively mark down portcos and why)
Net New Investments — 2-3 lines about each company + what’s promising + why’d you invest + website link + key highlights (you’ll need sign off from your founders for this last one)
Asks — for your portfolio and for your fund
Team updates — if your team changed (i.e. new hires)
General portfolio updates — the good, the bad, the ugly
Capital call schedules / Legal stuff if any
Insights into the market (if any)
In general, you want to tell your LPs if there are any updates before they find out about them themselves. Better to hear from you than from other channels.
Lastly, I like personal flare and highlights as well. But hell, that’s up to each GP’s preference.
The “sales” update
So, there will be some overlap of information with the earlier type of update. With some redactions, particularly the specific numbers on the portfolio side. That said, rather than what goes in it, what might be more helpful is how to think about it.
Sales, like in any other industry, requires you to know your customer.
Some general framing questions:
Are they the solution to your problem or are you the solution to their problem?
For instance, are they actively looking to deploy? Why? What motivates them? If not, you might be pushing a rock uphill. If yes, are you actually what they’re looking for, or can you better triage them to a friend who is investing in what they’re looking for. Relationships are long.
Do they see VC as an access class or an asset class?
Generally, not always, individuals and family offices see VC as an access class. So they care more about co-investment opportunities, deal flow for them to directly invest, and/or opportunities to learn from you. In other words, these LPs want to see what you’re investing in, who else is validating your investments, and what are you seeing and learning. If you’re a Fund I, you’re probably spending more time with these LPs.
Institutions, like foundations, endowments, pensions, and fund of funds, see VC as an asset class. As such, returns and performance matter a lot more. So the best ways to convince them is to let the numbers do the talking AND how close you stick with your initial strategy and if you deviate, why. Promise fulfillment, or in LP lingo, consistency of strategy, matters just as much as returns, if not more, once return profiles measure up to 3-5X across several years. Or when and how quickly DPI hits 1X. If you’re a Fund II+, you’re probably spending more time prospecting these.
Are you looking to institutionalize your fund? To go from a fund to a firm?
If so, how do you set yourself up to grow in team? How are you knocking out key risks one by one?
And in a loose way, not for an LP update, what happens once you get hit by a bus?
What kind of cadence makes sense for you and is enough to keep you top of mind for these LPs?
Including events you’re hosting or when you’re visiting certain geographies are always a nice added bonus.
And lastly, getting feedback is always important. As you might suspect. So that your communication between both your existing and prospective LPs only improves over time.
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.
Ok, before y’all rise up in arms, hear me out. And if by the end of this blogpost, you still want to bring the pitchforks and torches, so be it.
Generally, I get it. Who else is investing isn’t usually a great question. Because for most investors who ask this question, it means they’re outsourcing their conviction.
POV: you're at a tech week event full of contrarian investors who back founders at the earliest stage in frontier industries pic.twitter.com/k7p1cVNHjs
In fact, I wrote a quick LinkedIn (and tweet) post about it the day before yesterday. Which admittedly got a lot more attention than I expected. And if you have the time, it’s worth seeing the discussion on that post that ensued.
So, potentially hot take, I believe investors should ask the question. Who else is investing? It’s part of the diligence process. That said, when they ask that question is key. There’s a vast ocean between the shores of asking that question before you reach conviction and after.
If you pop the question before you reach conviction, well, we’ve seen the follies of that. Most evidenced by the manic rush of 2020 and 2021 into “hot deals” largely led by names that grew to popularity around the dinner table.
If you pop it after, it’s diligence. Where the availability of names shouldn’t convince you to bat or lack thereof to otherwise. But that you now have additional opportunities to reference check and cross-diligence the same opportunity. And it extends to the LP side as well. Jamie Rhode who’s now at Screendoor, said on a Superclusters episode that one of her greatest lessons as an LP was committing to a fund where there was a bunch of soft commits but far less in hard commits, and ended up overexposing Verdis (where she was at) to a single asset and taking a much higher ownership as an LP into a single fund.
Truth is, LPs pay GPs for their opinion. Not anyone else’s. And while given long feedback loops, no one really knows what’s right and what’s wrong except over a decade later and only in hindsight, you have to really believe it, and be able to back it up.
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.
Would the founders in your portfolio let you in on the cap table if you weren’t an investor? If you had no money? If they could only borrow your brain for two hours every three months, and that’s it?
The uncomfortable truth is that most founders won’t.
But to find the founder who will take that deal is the person you want to be focusing on. They’re the archetype of founder you want to win — that you put your whole heart into perfecting your craft for that founder.
Play to your strengths, not your weaknesses. Where do you have home field advantage?
Why does this matter?
All cards on the table, it won’t matter if you plan to stay a boutique VC firm or angel whose check size for an investment never goes past $250K. Even better if you don’t have any pro rata. But if you plan to institutionalize your firm — and I don’t mean to say this is the only way to institutionalize — you need to hire. To hire, you need enough management fees to support a team of that size. And to get enough management fees, most of the time, that requires you to scale your fund size.
Whereas in Fund I and maybe II, you played the participating investor. Squeezing in great deals. And everyone’s your friend. Founders love you. Your co-investors love you. With larger funds, you may end up scaling your check size. If you don’t, you start diversifying your portfolio more and more. And most large LPs prefer concentrated portfolios. Why?
They often do the diversification work in their own model. They pick their own verticals and stages they want exposure to. The product they want to buy is not to be their portfolio for them, but that it is just one asset in a larger portfolio. A lot of LPs also fear diversified portfolios in managers because at some point, managers will be investing in the same underlying asset. No LP wants to invest in 10 funds and have four of them all be investors in Stripe. If that’s the case, they might as well invest directly in Stripe via co-investment.
But at the end of the day, if your checks are bigger (along with ownership targets), it’s hard to always be 100% friendly with other investors since they have their own mandates. And at some point, the founder is forced to pick: you or any of those other interested investors.
And for you to win that deal, you must have something enduring that founders want outside of capital.
Examples
Of course, there are different ways to prove that you can win deals to your prospective LPs. The list below is by no means all-encompassing, but may help in giving you an idea of how people who have walked the path before you have done so.
Being chosen as the independent board member in other companies you didn’t invest in (Kudos to Ben Choi for sharing this one in our episode)
Even better if super pro rata (rarely happens though, especially after Series A)
(Co-)Leading rounds (met an emerging GP last year who syndicated the whole $2M round)
Repeat founders (with previous exits >$100M) let you invest in oversubscribed rounds with a check larger than $250K
Founders letting you invest on previous round’s terms (or highly preferential treatment)
Incubating the company
Evidence or repeatable ability for you to pre-empt rounds before founders go out to fundraise
Some combination of the above
In closing
Unintentionally, this blogpost is the unofficial part two of my first one on the topic of sourcing, picking, and winning. Part one was on sourcing. This one is on winning. No guarantees on picking, but who knows? I may end up writing something.
For the uninitiated, this was said by both Ben Choi and Samir Kaji on the Superclusters podcast. That to be a great investor, you need to be great in at least two of three things: sourcing, picking, and/or winning. If you only have great deal flow, but don’t know how to pick the right companies that come your way or have the best founders pick you, then you don’t have an advantage. If you’re really good at winning deals, but no one comes to you or you pick the wrong deals to win, then you also don’t have anything. You need at least two. Of course, ideally three.
But as you institutionalize, the third may come in the form of another team member or as you build out the platform.
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.
Jeff is a partner at Renaissance Venture Capital an innovative venture capital fund of funds. Jeff’s diverse background in venture capital and technology and his experience working in various start-up ventures uniquely position him to advise startups. In addition, Jeff is quite active in the Michigan start-up community, volunteering his time to mentor young entrepreneurs, judge pitch competitions, and guest lecture student classes and organizations. Through Jeff’s work on the Fund, his volunteer efforts, and his role as the chair of the Michigan Venture Capital Association’s board of directors, his passion for fostering a productive environment for venture capital investment in the State of Michigan is evident.
Martin Tobias is the Managing Partner and Founder of Incisive Ventures, an early-stage venture capital firm focused on investing in the first institutional round of technology companies that reduce friction at scale.
Martin was previously at Accenture and Microsoft and is a former Venture Partner at Ignition Partners. Martin is a 3X venture-funded CEO rising over $500M as CEO with two IPOs who has also invested in hundreds of companies and is a limited partner in over a dozen VC funds. Martin was an early investor in Google, Docusign, OpenSea, and over a dozen Unicorns.
Martin is the father of 3 daughters, a cyclist, surfer, poker player, and life hacker. Martin tinkers with motorcycles on the weekends. He writes about Venture Capital on Incisive Ventures blog and Twitter.
[00:00] Introducing Jeff Rinvelt and Martin Tobias [04:14] What was Jeff’s pitch to their LPs for Renaissance Capital? [06:30] Why did Jeff pivot from being a founder to an LP? [08:10] Renaissance Capital’s portfolio construction model [13:00] Jeff’s involvement in non-profits [15:56] How did Martin become an angel investor? [18:03] The big lesson from being an LP in SV Angel’s Fund I and II [20:10] Why is Martin starting a fund now? [26:07] A lesson on variable check sizes [28:53] What is Martin’s value add to founders? [33:29] What stood out about Martin’s deck and email when it arrived in Jeff’s inbox? [35:43] The 2 biggest worries Martin had in sharing his deck with Jeff [36:47] What does Jeff think about generalists? [40:49] What held Jeff back from making an investment in Incisive Ventures? [42:37] What kinds of conversations does Martin usually have with LPs? [47:05] One of the greatest professional lessons Jeff picked up as a manager [49:07] Martin’s greatest lesson from his days as a CEO [51:57] Thank you to Alchemist Accelerator for sponsoring! [54:33] Like, comment and share if you enjoyed the episode
“One of the things a lot of investors don’t do is go back and be honest about where they got fucking lucky and where they had a thesis that they could potentially replicate in future investments.”
Samir Kaji is the CEO and Co-Founder of Allocate, a private markets technology company that pairs origination with portfolio management tools to allow investors to efficiently construct and manage their alternatives portfolios.
Prior to Allocate, Samir spent 22 years in venture banking between SVB and First Republic Bank and closely worked with and advised over 700 venture capital and private equity firms. During this time, he completed over $12B in structured debt transactions and has invested personally in over 75 funds and companies, including early-stage investments into Carta (seed), Side (seed), PolicyGenius (Series A), and FanDuel (Series B) as well as Growth investments into Reddit, Alto Pharmacy, and Carbon Health. He has also invested in over 40 funds across various investment types.
Samir completed a finance undergraduate degree at San Jose State University, a finance MBA from Santa Clara University, and completed the prestigious Kauffman Fellows venture program in 2017. Samir is also the host of Venture Unlocked, a top venture capital podcast available on Itunes, Spotify, and Substack.
[00:00] Intro [04:15] What will be the biggest change in the next decade for the LP universe? [08:45] Portfolio allocation for emerging LPs [12:32] How has Samir’s LP investment strategy evolved over the years? [16:04] Why Samir invested in Bullpen Capital’s Fund I [17:43] GP-business model fit [19:40] GP red flags [21:00] The one question Samir asks to see if GPs understand how to do portfolio math [23:31] The art of asking good questions [29:44] What is the Minimum Viable Fund? [36:14] How to pick 10 funds out of 4000 VC funds [42:19] How did Samir pitch Allocate to his investors? [48:11] The first hires at Allocate [50:53] How Samir defines work-life integration [56:38] The first two emerging fund managers Samir backed at First Republic Bank [59:41] The lesson Samir’s father shared with him when he thought about leaving SVB [1:02:41] What happens when you overanalyze [1:07:27] Thank you to Alchemist Accelerator for sponsoring! [1:10:02] If you liked it, give us a like or share!
“When you think about investing in any fund, you’re really looking at three main components.
It’s sourcing ability. Are you seeing the deals that fit within whatever business model you’re executing on?
Do you have some acumen for picking?
And then, the third is: what is your ability to win? Have you proven your ability to win, get into really interesting deals that might’ve been either oversubscribed or hard to get into? Were you able to do your pro rata into the next round because you added value?
“And we also look through the lens of: Does this person have some asymmetric edge on at least two of those three things?”
“When you’re investing in a fund, especially when you’re making an ex ante decision, meaning you’re not buying a secondary, you’re actually just looking at what’s the probability of success in the future. You want to focus on process, more than just outcomes in the past. The process is how they think.”
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.
Soooooooo… (I know, what a great word to start a blogpost) I started this essay, with some familiarity on one subject. Little did I know I was going to learn about an entirely different industry, and be endlessly fascinated about that.
The analogy that kicked off this essay is that re-upping on a portfolio company is very much like re-signing a current player on a sports team. That was it. Simple as it was supposed to sound. The goal of any analogy was to frame a new or nuanced concept, in this case, the science of re-upping, under an umbrella of knowledge we were already familiar with.
But, I soon learned of the complexity behind re-upping players’ contracts, as one might assume. And while I will claim no authority over the knowledge and calculations that go into contracts in the sports arena, I want to thank Brian Anderson and everyone else who’s got more miles on their odometer in the world of professional sports for lending me their brains. Thank you!
As well as Arkady Kulik, Dave McClure, and all the LPs and GPs for their patience and willingness to go through all the revisions of this blogpost!
While this was a team effort here, many of this blogpost’s contributors chose to stay off the record.
The year was 1997.
Nomar Garciaparra was an instantaneous star, after batting an amazing .306/.342/.534. For the uninitiated, those are phenomenal stats. On top of batting 30 home runs and 11 triples – the latter of which was a cut above the rest of the league, it won him Rookie of the Year. And those numbers only trended upwards in the years after, especially in 1999 and 2000. Garciaparra became the hope for so many fans to end the curse of the Bambino – a curse that started when the Red Sox traded the legendary Babe Ruth to the Yankees in 1918.
Then 2001 hit. A wrist injury. An injured Achilles tendon. And the fact he needed to miss “significant time” earned him a prime spot to be traded. Garciaparra was still a phenomenal hitter when he was on, but there was one other variable that led to the Garciaparra trade. To Theo Epstein, above all else, that was his “fatal flaw.”
Someone that endlessly draws my fascination is Theo Epstein. Someone that comes from the world of baseball. A sport that venture draws a lot of inspiration, at least in analogy, like one of my fav sayings, Venture is one of the only types of investments where it’s not about the batting average but about the magnitude of the home runs you hit.
If you don’t follow baseball, Theo Epstein is the youngest general manager in the history of major league baseball at 26. But better known for ending the Curse of the Bambino, an 86-year curse that led the Red Sox down a championship drought that started when the Red Sox traded Babe Ruth to the Yankees. Theo as soon as he became general manager traded Nomar Garciaparra, a 5-time All-star shortstop, to the Cubs, and won key contracts with both third baseman Bill Mueller and pitcher Curt Schilling. All key decisions that led the Red Sox to eventually win the World Series 3 years later.
And when Theo left the Red Sox to join the Chicago Cubs, he also ended another curse – The Curse of the Billy Goat, ending with Theo leading them to a win in the 2016 World Series. You see, in baseball, they measure everything. From fly ball rates to hits per nine innings to pitches per plate appearance. Literally everything on the field.
But what made Theo different was that he looked at things off the field. It’s why he chose to bet on younger players than rely on the current all-stars. It’s why he measures how a teammate can help a team win in the dugout. And, it’s why he traded Nomar, a 5-time All Star, as soon as he joined, because Nomar’s “fatal flaw” was despite his prowess, held deep resentment to his own team, the Sox, when they tried to trade him just the year prior for Alex Rodriguez but failed to.
So, when Danny Meyer, best known for his success with Shake Shack, asked Theo what Danny called a “stupid question”, after the Cubs lost to the Dodgers in the playoffs, and right after Houston was hit by a massive hurricane, “Theo, who are you rooting for? The Dodgers so you can say you lost to the winning team, or Houston (Astros), because you want something good to happen to a city that was recently ravaged by a hurricane.”
Theo said, “Neither. But I’m rooting for the Dodgers because if they win, they’ll do whatever every championship team does and not work on the things they need to work on during the off season. And the good news is that we have to play them 8 times in the next season.”
You see, everyone in VC largely has access to the same data. The same Pitchbook and Crunchbase stat sheet. The same cap table. And the same financials. But as Howard Marks once said in response how you gain a knowledge advantage:
“You have to either:
Somehow do a better job of massaging the current data, which is challenging; or you have to
Be better at making qualitative judgments; or you have to
Be better at figuring out what the future holds.”
For the purpose of this blogpost, we’re going to focus on the first one of the three.
What is value?
To begin, we have to first define a term that’ll be booking its frequent flier miles for the rest of this piece – expected value.
Some defined it as the expectation of future worth. Others, a prediction of future utility. Investopedia defines it as the long-term average value of a variable. Merriam-Webster has the most rudimentary definition:
The sum of the values of a random variable with each value multiplied by its probability of occurrence
On the other hand, venture is an industry where the beta is arguably one of the highest. The risk associated with outperformance is massive as well. And the greatest returns, in following the power law, are unpredictable.
We’re often blessed with hindsight bias, but every early-stage investor in foresight struggles with predicting outlier performance. Any investor that says otherwise is either deluding you or themselves or both. At the same time, that’s what makes modeling exercises so difficult in venture, unlike our friends in hedge funds and private equity. Even the best severely underestimate the outcomes of their best performers. For instance, Bessemer thought the best possible outcome for Shopify was $400M with only a 3% chance of occurring.
Similarly, who would have thought that jumping in a stranger’s car or home, or live streaming gameplay would become as big as they are today. As Strauss Zelnick recently said, “The biggest hits are by their nature, unexpected, which means you can’t organize around them with AI.” Take the word AI out, and the sentence is equally as profound replaced with the word “model.” And it is equally echoed by others. Chris Paik at Pace has made it his mission to “invest in companies that can’t be described in a single sentence.”
But I digress.
Value itself is a huge topic – a juggernaut of a topic – and I, in no illusion, find myself explaining it in a short blogpost, but that of which I plan to spend the next couple of months, if not years, digging deeper into, including a couple more blogposts that are in the blast furnace right now. But for the purpose of this one, I’ll triangulate on one subset of it – future value as a function of probability and market benchmarks.
In other words, doubling down. Or re-upping.
For the world of startups, the best way to explain that is through a formula:
E(v) = (probability of outcome) X (outcome)
E(v) = (graduation rate) X (valuation step up from last round) X (dilution)
For the sake of this blogpost and model, let’s call E(v), appreciation value. So, let’s break down each of the variables.
Graduation rates
What percent of your companies graduate to the next round? I shared general benchmarks in this blogpost, but the truth is it’s a bit more nuanced. Each vertical, each sub-vertical, each vintage – they all look different. Additionally, Sapphire’s Beezer recently said that it’s normal to expect a 20-30% loss ratio in the first five years of your fund. Not all your companies will make it, but that’s the game we play.
On a similar note, institutional LPs often plan to build a multi-fund, multi-decade relationship with their GPs. If they invest in a Fund I, they also expect to be there by Fund III.
Valuation step ups
How much greater is the next round’s valuation in comparison to the one in which you invested? Twice as high? Thrice? By definition, if you double down on the same company, rather than allocate to a net new company, you’re decreasing your TVPI. And as valuations grow, the cost of doubling down may be too much for your portfolio construction model to handle, especially if you’re a smaller sub-$100M fund.
It’s for the same reason that in the world of professional sports, there are salary caps. In fact, most leagues have them. And only the teams who:
Have a real chance at the championship title.
Have a lot in their coffers. This comes down to the composition of the ownership group, and their willingness to pay that tax.
And/or have a city who’s willing to pay the premium.
… can pay the luxury tax. Not to be too much of a homer, but the Golden State Warriors have a phenomenal team and are well-positioned to win again (at least at the time of this blogpost going out). So the Warriors can afford to pay the luxury tax, but smaller teams or teams focused on rebuilding can’t.
The Bulls didn’t re-sign the legendary Michael Jordan because they needed to rebuild. Indianapolis didn’t extend Peyton Manning’s contract ‘cause they didn’t have the team that would support Peyton’s talents. So, they needed to rebuild with a new cast of players.
Similarly, Sequoia and a16z might be able to afford to pay the “luxury tax” when betting on the world’s greatest AI talent and for them to acquire the best generative AI talent. Those who have a real chance to grow to $100M ARR, given adoption rates, retention rates, and customer demand. But as a smaller fund or a fund that has a new cast of GPs (where the old guard retired)… can you?
Dilution
If a star player is prone to injury or can only play 60 minutes of a game (rather than 90 minutes), a team needs to re-evaluate the value of said player, no matter how talented they are. How much of a player’s health, motivation, and/or collaborativeness – harkening back to the anecdote of Nomar Garciaparra at the beginning – will affect their ability to perform in the coming season?
Take, for instance, the durability of a player. If there ‘s a 60% chance of a player getting injured if he/she plays longer than 60 minutes in a game and a 50% of tearing their ACL, while they may your highest scorer this season, they’re not very durable. If that player missed 25% of practices and 30% of games, they just don’t have it in them to see the season through. And you can also benchmark that player against the rest of the team. How’s that compared with the team’s average?
Of course, there’s a parallel here to also say, every decision you make should be relative to industry and portfolio benchmarks.
How great of a percentage are you getting diluted with the next round if you don’t maintain your ownership? This is the true value of your stake in the company as the company grows.
How does one use the appreciation value equation?
E(v) = (graduation rate) X (valuation step up from last round) X (dilution)
If the expected value is greater than one, the company is probably not worth re-upping. And that probably means the company is overhyped, or that that market is seeing extremely deflated loss ratios. In other words, more companies than should be, are graduating to the next stage; when in reality, the market is either a winner-take-all or a few-take-all market. If it is less than or equal to one, then it’s ripe to double down on. In other words, the company may be undervalued.
And to understand the above equation or for it to be actually useful (outside of an abstract concept), you need market data. Specifically, around valuation step ups as a function of industry and vertical.
If you happen to have internal data across decades and hundreds of companies, then it’s worth plugging in your own dataset as well. It’s the closest you can get to the efficient market frontier.
But if you lack a large enough sample size, I’d recommend the below model constructed from data pulled from Carta, Pitchbook, and Preqin and came from the minds of Arkady Kulik and Dave McClure.
The model
The purpose of this model is to help your team filter what portfolio companies are worth diving deeper into and which ones you may not have to (because they didn’t pass the litmus test) BEFORE you evaluate additional growth metrics.
It is also important to note that the data we’ve used is bucketed by industry. And in doing so, assumptions were made in broad strokes. For example, deep tech is broad by design but includes niche-er markets that have their own fair share of pricing nuances in battery or longevity biotech or energy or AI/ML. Or B2B which include subsectors in cybersecurity or infrastructure or PLG growth.
Take for instance…
Energy
Energy sector appreciation values and follow-on recommendations
The energy sector sees a large drop in appreciation value at the seed stage, where all three factors contribute to such an output. Valuation step-up is just 1.71X, graduation rates are less than 50% and dilution is 38% on average.
Second phase where re-upping might be a good idea is Series B. Main drivers as to such a decision are that dilution hovers around 35% and about 50% of companies graduate from Series A to Series B. Mark ups are less significant where we generally see only an increase in valuation at about 2.5X, which sits around the middle of the pack.
Biotech
Biotech sector appreciation values and follow-on recommendations
The biotech sector sees a large drop in appreciation value at the Seed stage. This time, whereas dilution seems to match the pace of the rest of the pack (at an average of 25%), the two other factors shine greater in making a follow-on decision. Valuation step up are rather low, sitting at 1.5X. And less than 50% graduate to the next stage.
In the late 2023 market, one might also consider re-upping at the Series C round. Main driver is the unexpectedly low step-up function of 1.5X, which matches the slow pace of deployment for growth and late stage VCs. On the flip side, a dilution of 17% and graduation rate of 60% are quite the norm at this stage.
In closing
All in all, the same exercise is useful in evaluating two scenarios – either as an LP or as a GP:
Is your entry point a good entry point?
Between two stages, where should you deploy more capital?
For the former, too often, emerging GPs take the stance of the earlier, the better. Almost as if it’s a biblical line. It’s not. Or at least not always, as a blanket statement. The point of the above exercise is also to evaluate, what is the average value of a company if you were to jump in at the pre-seed? Do enough graduate and at a high enough price for it to make sense? While earlier may be true for many industries, it isn’t true for all, and the model above can serve as your litmus test for it. You may be better off entering at a stage with a higher scoring entry point.
For the latter, this is where the discussion of follow on strategies and if you should have reserves come into play. If you’re a seed stage firm, say for biotech, using the above example, by the A, your asset might have appreciated too much for you to double down. In that case, as a fund manager, you may not need to deploy reserves into the current market. Or you may not need as large of a reserve pool as you might suspect. It’s for this reason that many fund managers often underallocate because they overestimate how much in reserves they need.
If you’re curious to play around with the model yourself, ping Arkady at ak@rpv.global, and you can mention you found out about it through here. 😉
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’s this line I love in Jerry Colonna’s Reboot, and I’m loosely paraphrasing just because I’m travelling and I don’t have the book in front of me, “The saying is buy low, sell high; not buy lowest, sell highest.”
The reason I bring up that line is that I’ve been hearing a lot of investors talk about timing the market. At least that was the case before this wonderful trip I’ve been taking across the Pacific, as I sip my hojicha atop my hotel in the backdrop of the Kyoto evening metropolis. When’s a good time to sell? What price makes sense on the secondary market? Should I be investing now? When’s a good time to re-up? Is it a good idea to re-up? Should I be generating DPI for my investors now? Or should I hold? When should I start my fund? When should I begin fundraising?
Now, I don’t pose the above questions as if I have all the answers. In fact, I don’t. I try to. But I don’t. Although I’ve heard 50-60% is the discount secondary buyers have been able to get for great companies that became overvalued in the pandemic days. On the flip side, while Dave and I did published a blogpost not too long ago on early DPI, the truth is there are different ways to make money. Ed Zimmerman shared some of his investments’ data recently to illustrate that exact point.
Another obvious truth is that as investors for an alternative asset class — hell for any asset class, our job is to make our LPs money. Ideally, more money than we were given. For other asset classes, it’s measured in percentages. For venture, it’s multiples. And because of that raison d’être, it’s our job to think not only about the upside, but also the downside protection. Hence, why early DPI matters in some of your best outliers. It always matters.
But from what I’m seeing and hearing, it matters more in a bear market, like today. Than the bull we were in yesterday. Why?
Liquidity is a differentiator.
Because of the point 1, giving LPs some liquidity back makes it easier to get to conviction as you raise your next fund.
Point 2 holds the most weight if you’re an emerging manager on Funds I through III, or have sub $100M AUM. Although Funds I and II, you have little to go off of. As such, sticking to your strategy may be more important to some LPs. In other words, consistency.
Also seems to matter more if your LPs are investing off balance sheet. For instance, corporates.
While I was in Tokyo earlier this trip, I caught up with a colleague. We spent the evening chatting about fund managers and current deployment schedules. (In case you’re wondering, no, we didn’t spend the whole time talking the biz.) And we see a lot of folks slowing down their pace of deployment. Could be the case of deal flow contraction, as Chris Neumann recently wrote about. Could be the case of loss of conviction behind initial fund strategy. We’ve also seen examples of VCs stretching their deployment schedule as their fundraises have been extended to 2024. All in all, that means VCs’ bar for “quality” has gone up.
But let me explain in a bit why I put “quality” in quotation marks.
So, timing comes down to two things:
Entry point
Exit point
I’ve seen a plurality of investors consider exit options as a means to *crossing fingers* convince existing LPs to re-up to the next fund. Debatable on how effective it is. As many LPs I’ve chatted with are “graduating” a lot more of their GPs than years prior. In other words, fancy shmancy word for they’re not re-upping on certain existing managers. Some LPs say it’s an AUM problem (but I’ve also seen them make exceptions). Others say it’s strategy drift. But more so say that certain GPs haven’t been a good fiduciary of capital, which ends being a combination of:
High entry points
Faster than promised deployment schedules (i.e. 1-1.5 years instead of 2-4 years)
Investing in a company where the preference stack is greater than the valuation of the company (similar to the first bullet point)
Reactive communication of strategy drift, instead of preemptive and proactive
Logo shopping which led to strategy drift
All that to say, there are a good amount of LPs who, though appreciate the extra liquidity from partial exits, are not re-investing in existing managers. In addition, they’re holding off until on new ones till earliest Q1 next year to build the relationship earlier. Especially those $5M+ checks.
So, quality, for both GPs and LPs, is this new sugar coating of a term to account for time it takes to figure out where they want to put the next dollar. Investors on both sides are waiting to pull the trigger at 90% conviction, instead of the usual 70%. And realistically, for pre-product market fit companies and firms (i.e. pre-seed, seed startups and Funds I-III), 90% usually never comes until it’s too late. Meaning one misses their entry point.
I have no doubt (as well as many if not all my peers) that the greatest companies of the next generation are being built today. But only a small handful will make it out the gauntlet of fire. Even good companies won’t make it, unfortunately.
So, for the one building, the importance of communicating focus and discipline will be more powerful than ever. My buddy Martin also recently tweeted by an unrelenting focus on a niche audience may serve more useful than targeting a seemingly large TAM.
For the one investing, there is no good time. Our job is to buy low, sell high. Not buy lowest, sell highest. Waiting for the right moment will only have you miss the moment. In the surfing analogy, where the market is the wave, the product is the board, the team is the surfer, and you need all three to be a great surfer, you don’t want to be on the shore when the wave hits. It is better to be paddling in the water before the wave hits than on the shore when the wave does hit. Timing is only obvious in hindsight, never in foresight.
There’s also a great Chinese proverb that the best time to plant a tree was 20 years ago, the next best time is today.
So in this flight to quality, consider what quality actually means. Is it a function of you doubting your original thesis? Then re-examine what caused the doubt. Was your thesis founded on first principles? For consumer, which is where I know a little bit more about, is it founded on the basis and habits of the human condition? Is it secular from technological and hype trends?
Is quality waiting on numbers or external validation? That’s fine if you’re a growth or late stage investor. You’re never going to get it if you’re a true pre-seed and seed. If you’re waiting on a large amount of traction, you’re not an early-stage investor. Round-semantics aside.
You built a fund around a 10-15 year vision. Deploy against that. Or… although we don’t see this much these days, return any remaining capital back to your LPs.
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.
This past weekend, I ended rewatching a classic and one of my favorite Eddie Murphy movies, A Thousand Words. Eddie, who plays Jack McCall, a literary agent, is someone who will say anything to get what he wants. And the plot of the movie effectively revolves around him trying to sign his next author and the after effects of doing so.
At one point, Dr. Sinja, the author he’s trying to sign, tells Jack, after he exclaims that he tells his wife he loves her “all the time”, “Words? More words, Jack. You tell her, like meaningless leaves that fly off a dying tree?
“Words.
“Can’t you show her that you love her? Make peace. Show them that you love them. And be truthful.”
One of my favorite people in the world, my friend who I met by way of mutual friend introduction, also happens to be one of the more well-traveled people I know. While it’s not my intention to embarrass her by writing this blogpost, she’s someone I’m deeply grateful for — my pen pal.
Every time we text, we send these long passages to each other. Paragraphs long. It doesn’t happen super often, every 2-3 months or so. And at times, we go six months without texting each other. But what makes her awesome aren’t our virtual letters, while I do really enjoy writing and reading them. What makes her awesome is that every time we meet in-person, she brings me gifts from abroad.
And she did so, ever since the day we first met, and I, in a passing remark, mentioned I didn’t travel often. And because of my work, my school, the need for me to be close to take care of family, I’ve stayed in the cocoon of the Bay Area my whole life. As such, I really do enjoy when friends tell me in detail of their travels beyond the horizons. But she took it a step further, where she would:
Buy gifts, snacks and souvenirs from abroad to bring back
Mail me postcards from every trip, sharing the smells, sights, sounds, and feels of her surroundings as she writes them
And of course, bring me back tales from her adventures when we meet in person.
They’re small things. But despite being small, they mean a lot to me.
I’m luckier now to be able to travel more. And just like my pen pal brings back treasures when she travels, I do so for her now too.
And of course, this extends beyond friendships. The fundamentals for any relationship (friendship, romantic, customer, investor, or some other business relationship) are fulfilling promises. Too often, I meet folks, who like Jack McCall say more than they can deliver. Most times unintentionally. A large part due to society’s expectations to be nice.
I’ll give an example. How often do we hear “How can I help?” at the end of a conversation? If you’re anyone who has something that others want — connections, capital, or advice — the ones on the receiving end probably wish to pay you back in some way. But most people ask that, and when they get an answer back, they take it in like the passing wind. Personally, I’d rather people who can’t deliver on that not ask that question than ask and not deliver (if there is something the other could use help on).
To go beyond just a normal relationship means you need to deliver the unexpected — beyond the initial promise. That requires you to actually spend time caring. And when you do, actions will naturally follow words or perform independent of words.
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
All cards on the table, I love conferences. It’s a great exchange of ideas. And every once in a while, you meet some really cool people. In fact, I’ve met quite a few of my now-great friends via large events. And hell, I love swag! Like, frickin’ love them! Arguably too much so.
I also love events, and have deep respect for not only the magnitude, the effort, but also the creativity that goes into making great events great. And if you’re a regular fan of this humble piece of internet real estate, you’ve seen me write about it. If not, would recommend searching up “social experiment”, “community”, or “events” in the righthand side bar. But I digress.
So, all of this transpired, when a founder asked me publicly in a Slack community, “Is TechCrunch Disrupt worth going to, to meet investors?”
I love TC, and all it stands for! But if you’re looking to raise and meet VCs who’ll be interested in listening to you pitch, your bang for buck is better elsewhere. Not saying it’s not possible, but if you’re not on stage, it’s just a lot of wasted effort. Why?
VCs who are there are not looking there for deal flow, at least the good ones who have great pipelines.
‘Cause most people who are there are looking for investors as well. You’re not getting as much facetime with the right people as you would like. The ones you wanna get in front of are always the most popular ones.
On the flip side…
Why I think TC (or similar) is worth attending?
Conversion. Conferences should not be top of funnel for you. ‘Cause if it is, you’re one step too late. Maybe two steps. Use it as a conversion tool. Set up Zooms with investors prior. Then use IRL time to convert them into fans or reinforce why you’re awesome. I mean, have you ever been to a networking event where strangers intro themselves to you and you forget their name within 5 seconds? The same is true for most investors unless you have a story that’ll make you go viral. If that’s the case, then you really don’t need conferences anyway. (Unless you’re on stage.)
Hosting your own event/happy hour/fireside chat. Better to be a host of even a small intimate 6-8 person dinner than to be a participant. Participants are for the most part, forgettable. As a host, you’ll be able to live rent-free in someone’s mind for at least a few weeks.
Or purely for fun. Then yes, go have fun. Everything else is a cherry on top. Did I mention conference swag is usually really awesome?
In closing
Do I personally go to conferences?
No. Usually. This doesn’t have any bearing to a conference’s quality. In fact, I think events like Saastr’s, Upfront’s, All-In, just to name a few are very well-organized.
I’m just too busy.
I enjoy intimate conversations more. I’m an introvert, what can I say.
I like letting my creativity run wild by hosting my own.
So if you’re a founder fundraising, hopefully the above might be some helpful context when you are next at a crossroads in relation to event attendance. And yes, I find the above to be true if you’re an emerging manager fundraising as well.
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.
