Think like an LP to Get a Job in VC

I want to preface this piece by first saying, though I have LP (limited partner) friends, I’ve never been an LP. So take everything with a grain of salt. For that matter, even I have been an LP, still take this with a grain of salt. After all it’s just my one perspective on the world. Nevertheless, I hope this perspective helps to provide some context around the venture space. As it did for me.

For years, I’ve recommended my friends who were looking at startup job opportunities to think like a VC. And having chatted a number of firms over the years about scout, associate/analyst, venture partner roles, I’ve come to a new revelation. Or rather one that I’ve practiced for a while, but haven’t connected the dots until recently.

When you’re looking for VC job opportunities, think like an LP. I’ve written about the LP calculus a few times before, like:

Here are some questions I usually consider:

  • How have you thought about your own differentiation that gets you access to some of the uniquely fund-defining opportunities you have?
  • What are the startups in your anti-portfolio? And what have you learned since from them?
  • [if their funds are wildly different in fund size (i.e. Fund I – $20M, Fund II – $100M)] How do you think about fund strategy now versus Fund [t_now-1]?
    • For context, usually each subsequent fund doubles in size. i.e. Fund I $20M, Fund II $40-50M, Fund III $80-100M
  • [If they have fund advisors, EIRs, and/or scouts] How do you pick advisors? What is your mental model for picking scouts?
    • Or one of my favorite phrasings: How do you differentiate the good from the great [advisors/scouts]?

Over the weekend, my friend sent me a great podcast for me to unwind. In it, I found an unlikely hero soundbite. “Your library holds a lot of value that you may not know until the story arrives. […] No one’s selling characters ’cause they’re one story away from this character becoming a hit.” While its context is related to why Marvel won’t sell any of its superheroes, Alex Segura‘s, co-president of Archie Comic Publications, anecdote proves just as insightful to the world of venture.

Discovering first-time early-stage founders is hard. The same is true for finding the next killer GP or venture firm. AngelList’s Rolling Funds are democratizing access to capital, lowering the barrier to entry for emerging fund managers. And really the success of a fund is determined by its MOIC – multiple on invested capital. 5x and up would be ideal. And that, like I mentioned in my last blogpost, boils down to the fund’s top one or two winners. Loosely analogized to a fund’s unicorn rate (percent of portfolio that are unicorns). In other words, the “one [investment] away from this [fund] becoming a hit.”

To see if a fund can consistently find those stories boils down to its systems. Often times, you’re joining a fund that has yet to have a runaway success. Or a fund that has a fund returner. So, instead, you’re looking at their thesis and if their thesis allows them to be:

  1. The best dollar on the cap table of a startup in their scope
  2. Forward-thinking enough to see where the market is heading, rather than where it’s been
    • And by definition of being forward-thinking, taking bets/risks that few other VCs would, yet calculated enough to make logical sense given the trajectory of the market. In other words, is the thesis grounded on first principles, yet able to capture their second-order effects?
    • That, in turn, requires you as a VC applicant to have decent literacy in the market the firm is betting in.

As James Clear, author of Atomic Habits, wrote, “You do not rise to the level of your goals. You fall to the level of your systems.” What are their mental models? Fund strategy? How do they think about portfolio construction? About capital allocation? And more importantly, time allocation?

If you’re looking to learn more about GP-LP dynamics, I highly recommend Samir Kaji’s Venture Unlocked podcast and Notation Capital’s Origins podcast.

Photo by Micheile Henderson on Unsplash


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Mega vs Micro Funds – Where is the money going in the private markets?

markets, mega vs microfunds
Photo by William Felker on Unsplash

One of my buddies and his team recently successfully raised their Fund I, luckily before this recent downturn. Moreover, their fund is geared towards investments into frontier tech. And the Curious George in me couldn’t help but ask about his findings and learnings. In the scope of mega versus micro-funds, our conversation also spiraled into:

  • the current state of private markets,
  • VC-LP dynamics,
  • and, operators-turned VCs.

Here’s a snapshot of our conversation, which could act as a cognitive passport for newly-minted and aspiring VCs. For the purpose of this blog, I’ll call him Noah.

The Snapshot

David: How do you think the private markets will change in this pandemic?

Noah: In a way starting a fund is a lot like starting a company. It’s definitely a humbling process to be on the ‘other side’ of the table and feel what it’s like to be an ‘entrepreneur’ and fundraise.

Yeah the impact on the private market side is something i’m trying to figure out yet. I think it’s still a little early to denote the true extent of the impact. But nonetheless, in the short term, funding activity is bound to go down, people are speculating the duration of this event and waiting for prices to come down. We’re lucky to have closed some money before this happened but it’ll be extremely tricky for the next wave of new fund managers to raise their funds.

It’ll be an especially rough time for founders especially if it goes on for long enough, most VCs will probably try to cut losses by dedicating their attention to portfolios that have the highest chance of survival. This crisis is also different in the sense that it’s a virus which prevents people from regrouping quickly if it carries on.

David: And it’s partly due to a recent function of LPs under-allocating towards the VC asset class as a whole, with longer fund cycles (10 years [6-7 years now] + 2-year extensions). Before all this, the market had been performing rather well in the past few years (a solid 17-18% return YoY on the public markets, or these self-imposed liquidity events, versus venture where only the top quartile of VCs make better than market return). I believe the 2018 number for the top quartile annual IRR was 24.98%, which is, what, 3x in 5 years, but even then, its not enough to convince many LPs.

Although you have the rise in a new sort of private investor in both the secondary markets, as well as VC-LP functions, where firms LPs either invest directly, or VCs are now investing in other micro-funds, like Sapphire. With VCs writing more discovery checks, and so many recent exits in tech, syndicates, via SPVs (special purpose vehicles), has helped them develop relationships with founders early on and relatively no strings attached.

Noah: I think one metric that really stands out that everyone is thinking about is in terms of liquidity. Not only are companies staying private for longer, more and more new alternative asset classes are rising. Interestingly enough, a lot of the endowments or larger institutions we’ve talked to are over allocated in venture. For example, Duke has nearly 1/3 of their money allocated to VCs. One obvious way that VCs are tackling this is in the secondaries market, selling off equity earlier and earlier, so lower potential return profile but LPs generally love early indications of a good DPI.

And yep, microfunds is definitely a big trend as well. It’s simply not sustainable for half a bill/billion dollar early stage funds to exist. Some of the returns of these mega funds have been made public and they’re not looking too great, even if it’s still early for them. On the flip side, smaller funds are a lot easier to return and generally where the best performing vehicles can be found. Moreover, the traditional endowments and institutions have locked in to the Sequoias and Andreessens already, so new FoFs (fund of funds) and relatively newer endowments are always looking for who are the next best alternatives. It just so happened that we’re also seeing a wave of ex-operators coming into the world of VCs and starting new funds. They might not have the acumen to build a long-standing mega fund yet, but their technical expertise makes them a good candidate for more verticalized funds.

David: I totally agree with your sentiment that operators should go do specialized funds, that could be vertically aligned, or could be functionally aligned (i.e. marketing, growth, dev, design, etc.). I’ve had this long standing belief, and let me know what you think. If you’re a great VC, run a mega fund. But if you’re a good-to-okay VC, run a micro fund or an alternative funding vehicle.

As someone who’s good-to-okay, it’s more important to (1) hedge your bets, aka diversify your portfolio, and (2) collect data. Most newly-minted VCs don’t have the experience, like you said, on the other side of the table. Just because you’ve been a good student doesn’t mean you’ll be a good teacher. As someone starting off or just don’t have a stable track record for doing well (aka one shot wonders or the lagging 75% if not more, of the industry), you gotta collect data, to do better cohort/portfolio/deal flow analysis.

Whereas if you’re a great VC, you need the capital to commit to the best investments of your portfolio. So megafunds, plus growth funds, make sense. Although, admittedly great VCs are far and few between.

Noah: My two cents is that the trend of larger and larger fund sizes is ultimately the result of VCs becoming too competitive. It’s no longer enough that VCs have a platform team to help support portfolio companies because more and more other VCs are amassing large support teams too. Therefore as you mentioned, the true way for them to stand out is to have a multi-billion dollar fund that spans across multiple stages. So unlike an early stage fund that can only guarantee committing maybe up to, let’s say, $10MM in capital during their seed and series A, these new beasts can support you in the growth rounds as well, all the way to IPO, and more and more VCs are doing so.

The problem is that this is a recent trend that happened within the past decade, and it’s still quite early to judge the capabilities of some of these new mega funds and whether they’re qualified to manage such a large fund. Nonetheless, you do still see that some of the best funds out there are very disciplined in keeping a consistent fund size (e.g. USV, Benchmark, First round, etc.) simply because it’s so much harder to return a billion dollar fund versus a $250MM vehicle. Microfunds is another interesting trend. On one hand a lot of these newly-minted VCs simply don’t have the capability to raise a >$100MM+ fund in the first place. But there are also cases where the GPs are more than capable but still choose to keep it at a <$100MM vehicle. I’m guessing a lot has to do with the competitive environment we’re in nowadays. When you don’t have as high ownership targets because of your smaller fund, you’re more flexible with minority stakes and can thus co-invest and get into better deals.

What does this mean for founders?

In these trying times, the public discourse around venture financing has been that there’s still quite a bit of capital that has yet to be deployed and that investors are still looking to invest. Yet it is neither entirely true nor entirely false. There are still financings going on today. Admittedly, most of these started their conversations 2-3 months ago.

The goal is cash preservation over growth for many verticals and companies, and it’s no less true for private companies. In that theme, most investors’ first foremost focus is the wellbeing of their portfolio. And because of that priority, many investors are slowing their investing schedule for now. This is especially true for megafunds, where, as ‘Noah’ mentioned, requires much more to return the fund, much less make a profit.

On the flip side, I’ve seen smaller funds and angel syndicates still actively deploying in this climate. I’ve also heard concerns where this pandemic and downturn is going to affect their fundraising schedule for Fund II and Fund III, so they’re pressured with making bets now from their LPs.

Anecdotally, it shouldn’t be harder to raise funding now than before. Some of the greatest companies came out of the past few downturns (2000 and ’08). A caveat would be if you overvalued in a previous round and are still looking to maintain the valuation trajectory (up round over down round).

So keep hacking! Measure well! And stay safe!


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