One of my favorite Hunter Walk lines, and one I cite quite often is: “Never follow your investor’s advice and you might fail. Always follow your investor’s advice and you’ll definitely fail.”
Investors are more likely to drive a company to the ground than otherwise. Founders listen to the advice of people they deem to be more senior and more experienced than them, as if they were written into the Bible. The cold, hard truth for people who give advice is that:
Not all advice is created equal and most advice is situational.
Your advice is more likely to be useless than useful in the aggregate supply of advice.
Advice should always be taken with a grain of salt. And oftentimes, certain pieces of advice is overweighted given the brand of the person giving it (who is right vs. what is right) and/or given the number of times the advice is given.
I’m lucky enough to be asked to be an advisor to a small number of funds, startups, and non-profits. Nothing to ever be worth bragging about. In fact, sometimes I wonder why I have a seat at the table. Nevertheless, lucky to share a drink with people smarter than me. I also realize that I’m a work in progress, and love to learn, just for the sake of learning. I’m not the famous person in the room, nor am I the most experienced person in the room.
So…
I always preface my advice with “Take this with a grain of salt, and this is purely my opinion – one among many others. I trust you to make the final judgment call of what makes the most sense.”
I give the unorthodox opinion. If I don’t have one, I don’t share any advice. I will caveat that I play in the early stages of company formation, when organizations are more so the pirates than the navy. When things are non-obvious, and need to fight to have a seat at the table. And given that the company and/or fund’s job is to question the status quo, I believe it is my job is to enable the founders to consider unorthodox paths. The minimum I can do is suggest that even if my advice is wrong, there are more paths than the one or two options we have in front of us. Or as Mike Maples writes in his book Pattern Breakers, “breakthroughs require pattern breaking.”
All in all, is my advice better than yours? Or anyone else’s? Who knows? But at least it’s different.
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.
One of my favorite sections in Danny Meyer’s Setting the Table (H/T to Rishi and Arpan from Garuda who not only gifted me that book, but also one of the nicest bookmarks I own today) is when he talks about whelmers.
“I ask our managers to weigh one other critical factor as they handicap the prospect. Do they believe the candidate has the capacity to become one of the top three performers on our team in his or her job category? If people cannot ever develop into one of our top three cooks, servers, managers, or maître d’s, why would we hire them? How will they help us improve and become champions? It’s pretty easy to spot an overwhelmingly strong candidate or even an underwhelmingly weak candidate. It’s the ‘whelming’ candidate you must avoid at all costs, because that’s the one who can and will do your organization the most long-lasting harm. Overwhelmers earn you ravers. Underwhelmers either leave on their own or are terminated. Whelmers, sadly, are like a stubborn stain you can’t get out of the carpet. They infuse an organization and its with mediocrity; they’re comfortable, and so they never leave; and, frustratingly, they never do anything that rises to the level of getting them promoted or sinks to the level of getting them fired. And because you either can’t or don’t fire them, you and they conspire to send a dangerous message to your staff and guests and ‘average’ is acceptable.”
In an industry where everyone is incredible — in many ways, you can’t, or at least it’s really hard to, be a GP without being overwhelming in your past in one way or another… INcredible becomes credible. So, it’s quite hard when you have a limited sample size to know who is incredible among the already incredible.
Almost everyone today is overqualified for the job, compared to the 1970s, 80s, and 90s, when most were underqualified.
So, unless you’ve been an LP, how do you know if you’re overwhelming versus just whelming?
LPs who have seen at least 200 funds in the last 2-4 years tell you you’re the “only” one who is pursuing this strategy
They have large enough of a sample size to make an assessment. While not perfect, it’s enough to be in rarified air.
You’ve been to the major LP/GP conferences (i.e. RAISE, Bridge, All Raise, SuperReturn / SuperVenture, Upfront Summit, Milken, EMC Summit, etc.) and have seen how other GPs pitch where you personally have a sample size of at least 100.
Even better, if you’ve been to the Demo Days or showcases for Coolwater, Recast, VC Lab, just to name a few, and you’ve seen other GP’s pitches
Do note what GPs say on podcasts are usually (in my experience) what they pitch to LPs.
You can cold email LPs and they’ll respond.
LPs are notoriously closed off to cold emails. As an institution that makes only 1-3 new investments per year in an asset class, it doesn’t make sense for them to keep the doors open as much as venture investors do for founders. And even then, a lot of VCs are also averse to cold emails. That said, if you’re a GP that consistently gets meetings booked from cold emails, you might have something special.
More often than not, admittedly, this is due to a strong brand, either via media, personal brand, strong returns, or word of mouth.
Important to note that you’re never as good as they say you are, but you’re also never as bad as they say you are.
When you are THE first call exited founders ($100M+ exits) make when they’re brainstorming their next company
Them needing a sparring partner on their next career move also counts.
You getting invited to whatever large event they host next does not. Including birthday parties, weddings, etc. As much as it feels good to me, you’re not overwhelming. If it puts things into perspective, I get invited to these, and I know I’m not an “overwhelming” venture investor.
Also if you’re the fifth person they call, you’re just “whelming.”
You are cited by other investors and founders alike as the source material of an ideology or a framework.
Not an investor (or at least I don’t know if he is), but Kevin Kelly is another great source of excellent soundbites.
Different founders (or people in general) reach out to you consistently on topics that is not fundraising/them pitching you. In fact, they may never reach out to you on fundraising because you’re known for excellence in other areas.
The best talent in the world want to work with you and they’ll find any way to do so. They’ll say things like, “What if we worked together on a small project first together?” or “How about this together?” The same world-class talent will not only prioritize your goals but also not forsake their own. ‘Cause frankly, the world’s best have their own pursuits and they are transparent and honest about it. Beware of people whose goal you don’t know and those that “give up” their dreams for yours.
You have a memory like a steel trap. You quote books, passages, movies, lessons, anecdotes, stories, history, podcasts, presidential speeches from back in the day, and music in ways most people cannot fathom but make complete sense. You quote in ways where people wonder if you have photographic memory or a chip in your brain, but you actually don’t.
This is more or less intellectually “overwhelming”, although overwhelming may not be the right terminology. But someone who is profusely well-read and cultured in a diverse amount of material. Think Da Vinci. Or maybe a modern-day equivalent, Patrick Collison, David Senra, or Ben and David on Acquired.
The one thing I won’t include on this list, while undeniably “overwhelming,” is intuition. People with phenomenal intuition are just different. Overwhelmingly different. But in the world of venture, the word intuition is often overused and has lost its true meaning. Many investors who bet well in hindsight attribute luck to intuition. And hell, the reason I’m not including it in the above list, is that many investors think they’re heavily intuitive, which in my experience usually means:
They hate math. Spreadsheets and the like. In fact, they’re likely just to be bad at it.
They hate diligence. The homework that’s actually required to be a great investor.
If they’re pre-economic success, they’re often spinning a tale to us. Or worse, lying to themselves.
If they’re post-economic success, there’s a good chance they have hindsight bias.
That said, there are a rare few number of times where I meet someone (often not an investor) and they’re able to deduce the person I am with a glance with very little other context. To me, that feels like magic. Something that very few have. But at the same time, I do believe can be trained.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
I’ve always admired the way Mike Maples has thought about backcasting. In summary, he proposes that true innovators are visitors from the future. Or as he puts it: “Breakthrough builders are visitors from the future, telling us what’s coming.” Such that they “pull the present from the current reality to the future of their design.” In other words, start from the future, then work your way backwards to figure out what you need to do today to get there.
And I find it equally as empowering to do the same exercise as an emerging manager. Hell, for any aspiring institutional investor. Be it from an angel to a GP. Or an individual LP to a fund of funds.
Start from your ideal fund model. Your ideal LP base. Your ideal pitch deck. Then work backwards to figure out what you need to do today. For the purpose of this blogpost, I’ll focus on reference checks.
For everyone in the investing world, especially in the early-stage private markets, we all know that reference checks is a key component of making investment decisions. Yet too often, founders and emerging managers alike think about them retroactively. Post-mortem. Testimonials that are often not indicative of one’s strengths. And especially not indicative of how a GP won that investment, as well as how they can win such investments in the future.
An exercise I often recommend investors do is write your ideal reference you would like to get from a founder. Be as specific as you can. What would your portfolio founders say about you? How have you helped them in a way that no one else can? What do founders who you didn’t fund say about you?
Another way to think about it is if you were to own a word — something that would live rent free in people’s minds — what would you own? Hustle Fund owns “hilariously early.” Spacecadet Ventures owns “the marketing VC” and they live up to it. Cowboy’s Aileen Lee created the idea of “unicorns.” “Software is eating the world” is attributed to Marc Andreessen.
On the flip side of the token, what are testimonials that should never be written about you?
Hell, at this point, if you’re an aspiring institutional investor, and have yet to spell things out, create the whole deck. Fill in the numbers and the facts later, but for now, make up your ideal deck. When leading indicators become lagging, then update it and fill it in.
Then be that kind of investor for every founder you help. As Warren Buffett once said, “You should write your obituary and then try and figure out how to live up to it.”
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.
Abe Finkelstein, Managing Partner at Vintage, has been leading fund, secondary, and growth stage investments focused on fintech, gaming, and SMB software, among others, leading growth stage and secondary investments for Vintage in companies like Monday.com, Minute Media, Payoneer, MoonActive and Honeybook.
Prior to joining Vintage in 2003, Abe was an equity analyst with Goldman Sachs, covering Israel-based technology companies in a wide variety of sectors, including software, telecom equipment, networking, semiconductors, and satellite communications. While at Goldman Sachs, Abe, and the Israel team were highly ranked by both Thomson Extel and Institutional Investor.
Prior to Goldman Sachs, Abe was Vice-President at U.S. Bancorp Piper Jaffray, where he helped launch and led the firm’s Israel technology shares institutional sales effort. Before joining Piper, he was an Associate at Brown Brothers Harriman, covering the enterprise software and internet sectors. Abe began his career at Josephthal, Lyon, and Ross, joining one of the first research teams focused exclusively on Israel-based companies.
Abe graduated Magna Cum Laude from the Wharton School at the University of Pennsylvania with a BS in Economics and a concentration in Finance.
Vintage Investment Partners is a global venture platform managing ~$4 billion across venture Fund of Funds, Secondary Funds, and Growth-Stage Funds focused on venture in the U.S., Europe, Israel, and Canada. Vintage is invested in many of the world’;s leading venture funds and growth-stage tech startups striving to make a lasting impact on the world and has exposure directly and indirectly to over 6,000 technology companies.
[00:00] Intro [03:22] How did Abe get his first job? [15:30] The currency of trust [17:12] How does Vintage view mistakes and weaknesses? [20:03] How Vintage organizes team offsites [28:42] The lessons Abe gained on people and long-term potential [33:47] Type 1 and Type 2 errors when evaluating GPs [36:00] How does Vintage work with their GPs and the GPs’ portfolio companies? [45:06] What Abe likes to see in a cold email [49:33] Funds that Abe says no to [51:18] When does fund size as a function of stage not make sense for Vintage? [54:51] Carry splits within a fund [1:02:08] What kinds of funds does Vintage not re-up in? [1:05:23] How did Abe become a Pitfall Explorer? [1:07:38] What Abe has learned over the years about patience? [1:11:05] One of Abe’s biggest blows in his career [1:16:23] Thank you to Alchemist Accelerator for sponsoring! [1:18:58] Like, comment and share if you enjoyed this episode!
I know I just wrote a blogpost on how LPs assess if GPs can win deals. But after a few recent conversations with LPs in fund of funds, as well as emerging LPs, I thought it would be interesting to draw the parallel of not only proxies of how GPs win deals, but also proxies of how LPs win deals. And as such, coming back with a part two. Maybe a part one and a half. You get the point.
The greatest indicator for the ability to win deals as a VC is to see what the largest check (and greatest ownership target) a world-class founder will take from you. (That said, if you are only capable of winning deals based on price, you might want to consider another career. You should have other reasons a brilliant founder will pick you.) And even better if they give you a board seat.
The greatest indicator for the ability to win deals as an LP is to see what the smallest check a world-class GP will take from you. And even better if they give you a seat on the LPAC.
In the world where capital is more or less a commodity, the more capital one can provide (with some loose constraints on maximums), the better. But if someone who has no to little trouble raising is willing to open doors in a potentially over-subscribed fund for you, that’s something special.
An LP I was chatting with recently loves asking the question, “How big of a check size would you like me to write?” And to him, the answer “As much as you can.” Or “I’ll take any number.” is a bad answer. According to him, the best GPs know exactly how much they’re expecting from LPs, and sometimes as a function of how helpful they can be, especially in a Fund I or II. But always as a function of portfolio construction. Your fund size is after all your strategy, as the Mike Maples adage goes. While I don’t know if I completely agree with this approach, I did find this approach intriguing, and at least worth a double take.
I’m forgetting the attribution here. The curse of forgetting to write things down when I hear them. But I was listening to a podcast, or maybe it was a conversation, where they used the analogy that being a VC is like watching your child on the playground. You let your child do whatever they want to. Go down the slides. Climb the monkey bars. Sit on the swings. And so on. You let them chart their own narratives. But your job as the parent is once you see your kid doing something dangerous, that’s when you step in. When they’re about to jump off a 2-story slide. Or swing upside-down. But otherwise your kid knows best on how to have fun. In the founders’ case, they know how to build an amazing product for an audience who’s dying for it.
Excluding the fact that you’re a good friend or family that go way back, you likely have something of great strategic value to that GP — be it:
Network to other LPs
Operational expertise and value to portfolio companies (to a point where you being an LP will help the GP win deals with founders)
Operational expertise to the GP and the investment team
Investment expertise to help check the GP’s blindside
Access to downstream capital
Deal flow, or
Simply, mentorship
At the same time, ONSET Ventures once found that “if you had a full-time mentor who was not part of the company’s management team, and who had actually run both a start-up and a larger business, the success rate increased from less than 25% to over 80%.” (You can find the case study here. As an FYI, the afore-mentioned link leads to a download of the HBS case study.)
That’s the role of the board. The LPAC. Of the advisory board. For a founder or emerging GP, the full-time availability of said board members or LPAC members is vital.
A proxy of a mentor’s availability is pre-existing relationships between founder/emerging funder and said investor or advisor. Another is simply the responsiveness of the investor or advisor. Do they take less than 12 hours to reply? Or 3-5 business days? It’s for that latter reason Sequoia’s Pat Gradyonce lost out on an investment deal to his life partner, Sarah Guo. Being responsive goes a long way.
In sum, for LPs in fund of fund managers, small things go a long way.
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.
The great Jim Collins has this line I really like where he says fire bullets then cannonballs. “The right big things are the things you’ve empirically validated. So, you fire bullets, you validate, then you go big — bullets, then cannonballs — it’s both.”
Too often — something I see in me as much as I see in founders — when trying something new, we bottle it up. We charge the entropy of our creativity. Waiting to release it all at one big moment. A cannonball. No one else should or needs to know know. Sometimes it’s a fear of someone else stealing your idea. Sometimes, well, speaking more for myself, I just like surprises. I love the mystique. And on the slim chance you’re right, albeit rare, then awesome. But 999 out of 1000 times, you’re likely not. At least not in the first try.
I’m forgetting and also can’t seem to find the attribution. But I read somewhere that the only difference between vision and a hallucination is that others can see it. You see… the greatest YouTubers test their ideas with test audiences several times. In fact, they even test their video titles with select audiences a number of times before launching. (Instagram even added the ability to do it at scale for creators too.) Reporters do too with their headlines. Legendary investor Mike Maples at Floodgate once said, “90% of our exit profits have come from pivots.” ONSET Ventures also found in its research1 that founded the institution back in 1984 (prescient, I know) that there is a 90% correlation between success and the company changing its original business model.
All to say, one’s first idea may not always be the best and final idea. So, test things. With small audiences. With trusted confidants.
And while I may not do this all the time, with my bigger blogposts (like this, this, and this), I always run it by co-conspirators, subject-matter experts, lawyers, writers, bloggers, and people who love reading fine print. And sometimes the final product may not look like the one I initially intended, which will be true for an upcoming bigger blogpost. For events, like one I recently worked with the team at Alchemist on — redefining what in-person Demo Days look like at accelerators, we tested the idea with 20 other investors and iterated on their feedback before launching on January 30th this year. And still is not even close to its final evolution.
As Reid Hoffman once said, “If you are not embarrassed by the first version of your product, you’ve launched too late.”
Now that it’s out there…
One of the greatest Joker lines in The Dark Knight is: “Trust no one, salt and sugar look the same.”
It’s true. Whether people like something or not, they’ll always tell you things were good. It’s the equivalent of when one goes to a restaurant, orders something that’s a bit saltier than one’s liking, but when the server comes by to ask, “How is everything?”, most people respond with “Everything’s fine.” Or “good.”
You’re not going to get the real answer out of people oftentimes. Unless people really do love or hate something you did passionately. So… you must hunt for them. You must lure out the answers. You need to force people to take sides. There can be and shouldn’t be middle ground. If there are, that means they don’t like it.
Maybe it’s in the form of the NPS question. On a scale of 1-10, how likely would you recommend this product to a friend? And you cannot pick 7.
In the event space, I’ve come to like a new question. If I invited you to this event the week of, would you cancel plans to make this event? And to add more nuance, what kinds of events would you cancel to be here? What kinds of events would you not cancel?
Sometimes it helps to seed examples on a spectrum (although I try not to lead the witness here). Would you cancel a honeymoon? Or would you cancel going to another investor/founder happy hour? What about an AGM (annual general meeting, annual conference in VC talk)? What about a vacation?
As Joker said, salt and sugar look the same. So you have to taste it. Looking from afar won’t help. And if you want to iterate and improve, you need what people really think. I’d rather have people hate or dislike something I’ve created than have a lukewarm or worse, a “good” reaction.
In a way, if you’re not getting enough of an auto-immune response from the crowd, and the antibodies don’t start kicking in (aka the naysayers), you’re not really doing something new.
1 FYI, the research link redirects to its HBS case study, not the original research. Couldn’t find the latter unfortunately. But the point stands.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
In the process of catching up with a number of fund managers this week, I was reminded of two things:
That I still have an outstanding blogpost on intuition and discipline sitting on my desk, having gone through more revisions than I would like
That Fund I’s mostly start by drawing trendlines in your previous portfolio’s winners.
Now it’s not my job to call anyone out, but many of those I caught up with this week, told me in confidence (no longer in confidence now that I’m writing about it) that their best investments were simply due to being in the right place at the right time. That they were lucky. Others invested often off-thesis to accommodate for a brilliant founder that looked and sounded like nothing they had seen before. Then retroactively, went back to LPs in a subsequent fundraise armed with the knowledge to account for their previous outlier.
Chris Paik once wrote, ““Invest in companies that can’t be described in a single sentence.”
Invest in companies that can’t be described in a single sentence
Josh Wolfe said last year, “We believe before others understand.” And sometimes the investor themselves may not fully grasp what makes someone special other than that person is special.
Other times the company in which you initially bet on may not look like the company that earns you the most capital. As Mike Maples Jr. once said, “90% of our exit profits have come from pivots.
Of course, many LPs don’t want to hear that. They want to hear that you know exactly what you’re doing. That you can predict the future. But you can’t. In many ways, VCs invest in what stays the same. Not what changes. Human nature. Great hires. Network effects. Talent pools. Intellectual curiosity. Rigor. It’s a long list.
An amazing VC once told me. The job of a VC is to:
Have a wide enough aperture so enough light can come in
But have a fast enough trigger finger to catch the light, the reflections, the shadows just at the right time so that you get a good enough shot.
The rest is all done in the editing room, where you massage the photo with your expertise and experience to help it stand out.
I love that line. But simply put, the job of a VC is to:
Cast a wide enough net so that you can see as many great companies as you can,
Have the ability and awareness to know a great company when you see it.
After all, as an investor, you don’t have to invest in every great company, but every company you invest in must be great. Big anti-portfolios don’t mean much in this world if you can still get great returns.
All that to say, the job of an angel is to increase the surface area for luck to stick. And once enough do, a thesis blossoms.
A thesis, at the end of the day, is retroactive. And the best thing a fund manager can do is that the thesis the fund ends on is as close as possible to the initial. As LPs, it is our job to bet on the future of the thesis and the discipline of the fund manager. Both are equally as important. If things do change, a fund manager must preemptively communicate strategy drift and do so in the best interest of their investors.
It’s not ideal in many cases. For individual LPs and smaller family offices, strategy drift matters less. For large institutional LPs, it matters more. Because the latter don’t want you to be investing in the same underlying asset as other funds they’re invested into are.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
I’ve had multiple conversations with emerging managers currently fundraising over the past few weeks, and the common theme, outside of the usual no’s, seems to be that larger LPs are saying, “If you were raising a larger fund, we would invest.”
And so there’s this catch 22 in the market right now. In one Fund I GP’s words, “either raise a larger fund and be told by the large checks that they don’t do Fund I’s. Or do a smaller fund, and be told by the high quality LPs that they’re too small.”
As a note, for the uninitiated, most large, seasoned LPs usually don’t want their check to be more than 10% of the fund. Why? Too much exposure in a single asset. And the need to diversify. Every year, there are really 20 great companies that are made. Or on the higher end, as Allocate’s Samir Kajirecently wrote, “30-50 companies drive the majority of returns.” Your goal as an LP, is to get as much exposure to those as possible. And they rarely all come out of just 1-2 funds.
If LPs are open to taking up more than 10% of the fund, they usually come with rather aggressive terms. For instance, investing into the GP stake, as opposed the to the LP. That’s a conversation for another day though.
As such, I’ve seen many a manager play both angles. They call it the “toggle.” If we raise a target of $10M fund, we’ll only do pre-seed. We’ll also have no reserves. If we raise a $25M fund, we’ll have 20% reserves and more seed checks. But if we’re able to close a $50M fund, we’ll have 33% reserves and do 50% pre-seed and 50% seed. The deltas between some fund managers’ targets and caps have grown as wide as the Grand Canyon. I was chatting with a Fund I GP yesterday who had a $10M target with $40M cap. Still relatively reasonable. Another GP raising their Fund I two weeks ago told me he had a $15M target and $70M cap. Far less reasonable. In fact, I might even say, a $15M fund and a $70M fund are two completely different strategies.
So begs the question, as a Fund I or II GP, is it worth raising a larger fund to possibly close large LPs or staying disciplined in your pre-product-market fit fund?
Spoiler alert… I don’t have the silver bullet. So if you’re looking for one, this blogpost isn’t worth your time.
But if you’re not, here’s how I’ve been thinking about it.
The short answer is really, whoever’s willing to give you money. Not the most sophisticated answer, but if you know large LPs well and they’re willing to invest in you, go bigger. Otherwise, you need to consider a more grassroots approach.
If you have a strong, portable, relevant track record that’s either returned good distributions already OR that has persisted for at least 6-7 years, larger LPs may be more open to investing in you. If not, you may need to play the numbers game with smaller LPs, that are liquidity-constrained as of now. And for that, you either take smaller checks, or prove you are the best option for their $250K LP check, that it somehow outcompetes the S&P, 3-year treasury bonds (because of interest rates), real estate and so on.
Also, remember that LPs are always nice in meeting #1. I’ve heard of very few instances where they’re not. A lot are just in exploratory mode. No pressure to commit. You will also need a great barometer of what nice looks like and what kindness looks like. Otherwise, you will waste a lot of time.
What does that mean? It is easier for a large LP to tell you “I will invest if your fund was bigger” than to tell you “No.” It’s the equivalent of VCs telling founders, “You’re too early for me.” And the same as recruiters and hiring managers telling job candidates “We have a highly competitive pool, and while we loved meeting you and you’re great…” There might be some truth to it, but a lot of smokes and mirrors, and a fear to offend people. I get it. We’re all people.
Just don’t lie to yourself.
Taking the hard road, which will be true for the vast majority of managers raising now, is to keep the fund size small and disciplined. Aim for a minimum viable fund. And deploy.
The minimum viable fund
Simply put, what is the minimum you need to execute your strategy? To set yourself up to raise a larger fund 1-2 funds from now?
What assumptions are you trying to prove?
What does your ideal Fund III look like? And What does fund-market fit look like to you? Be as detailed as you can. It could be that you’re getting four high quality deals per quarter. And that you have $30-40M to deploy per senior partner. That you’re leading rounds for target post-money valuations between $10-20M. That you have early DPI from Fund I by then. And so on.
Then work backwards. If that’s what Fund III looks like, what does Fund II look like? What does Fund I look like? As you’re backcasting, to borrow a Mike Maples Jr. term, each fund when you work backwards in time is focused on testing 1-2 key assumptions that you and LPs need to get conviction on. Assumptions that require data.
I’ll give an example of one kind of assumption. Your ability to win allocation.
If Fund III is where you lead pre-seed and seed rounds and have strong ownership targets, then Fund II is where you have to test if founders and other downstream investors will let you take pro rata for more than one round. And, if you can win or negotiate for that pro rata. It all comes down to, will a founder pick you over another awesome, possibly brand-name VC? And if so, why?
Some LPs prefer co-investment opportunities. And while it is helpful for them to go direct, part of the reason for it, is even if your fund can’t execute on the pro rata, just the ability to negotiate that is powerful for the day you need to lead. And if that’s Fund II, Fund I may be, can you win allocation in hot rounds and/or can you discover non-obvious companies before they become obvious?
Let’s say your Fund I is focused on the latter. You’re probably investing on $5-10M post-money valuations, and you’re going to try to maintain 5% ownership till the A-round. That’s $250-500K checks. $250K would be your base check, trying to get at least 30 shots on goal. That’s a $9-10M minimum viable fund, hoping for more than a 2% outlier rate in the generalist market, or north of a 10% outlier rate in bio, hard sciences, healthcare, or deep tech space.
Any less than 30 companies, you’re going for the hyper-concentrated portfolio and it’s a lot more about ownership and the greater the pressure, you need to pick well. But the goal is to get to a 3x net minimum for your fund by the time you get to a Fund III.
I heard from LPs with more miles on their odometer that once upon a time, it was normal for GPs to give undeployed capital back to their LPs. Circa 2002-2005 vintage funds. Where GPs don’t execute on 50% of their capital calls. But we don’t live in that era anymore. For better or worse.
Some LPs don’t even want their capital back early because then they need to pay taxes AND find another asset that compounds at the same or better rate your fund currently is. Say 25% IRR or CAGR. That’s hard. Because minus the inflated marks of the last 5 years, 25% is a hard benchmark to hit for the vast majority of funds.
So sometimes to be the best fiduciary, that means raising a small fund today (easier to return too) to set you best up for tomorrow.
The questions to ask
If you are in the midst of conversation and trying to court a large LP, do ask the following:
Have you invested in an emerging manager in the last two years? — If not, you’re unlikely to be their first. If you’re not seeing demonstrable progress from intro to partnership meeting to diligence within three meetings, move on. If they did so, 20 years ago, doesn’t count. That means investing in emerging managers is not top of mind for them.
What is your minimum check size? And how often, if ever do you deviate from it? If so, why was the last time you did so? — Multiply this number by 10. If it’s greater than your fund size, you might find more success elsewhere.
What is the typical process look like? — Find out what their process is and see if you’re progressing forward. If not, very clear they may not be interested.
(If the person you are talking to does seem to really like you) What are the questions you’re being asking in your investment committee? — Figure out the bottlenecks as soon as you can. And determine if that’s something you can solve for in the near future or not. If it’s track record, you realistically can’t.
What is the thing you hated most in the last few years? — Understand their red flags early on in the process. And cross your fingers, it’s not something that’s relevant to you or your fund. If it is, move on.
Of course, the above, while useful pre-qualifying questions, are mentioned in broad strokes. Your mileage may vary. Have there been examples of large LPs betting on small funds? Yes. But far and few in between. But don’t expect you will change many minds.
In closing
Fundraising is all about momentum and time you’re in market. You can theoretically spend six months trying to close one large LP, but your time might be better spent closing smaller checks in the beginning from people who believe in you and strong referenceable names. And if you so choose, come back to the large LP in the second half of your fundraise.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
VCs win upon liquidity event. And that happens either via M&A or via going public. After that, the shares are transferred to the hands of the LPs and they choose how they’d like to liquidate or keep. To date, we have neither seen a trillion dollar acquisition nor a trillion dollar IPO. I’m not saying it’ll never happen. I’m sure it will, at some point. A combination of inflation and companies finding more liquidity when private markets are bullish.
As Charles Hudson suggests in his one of his latest posts, the venture world has been changing. What was once a cottage industry gave way to multi billion dollar funds. While there are still many small sub-$100M funds, LPs have started evaluating venture capital not as just one big industry, but segmenting it by size of fund. Small funds, sub-$100M. Medium-sized funds, $100-500M. And big funds, funds north of $500M assets under management (AUM for short). And as the Mike Maples dictum goes, your fund size is your strategy.
Returning a billion-dollar fund requires different kinds of investments and math for it to work compared to returning a $50M fund. And one day, as large funds continue to expand into multiple stages, check size, but also eventually into public markets, we might see them start to bet on trillion-dollar outcomes. Because to return a 11- or 12-figure fund, you need to do just that. But given the market we’re in now, I imagine that won’t be in the near future.
The 10,000-foot view
So the thing you have to gain conviction around, as a macroeconomist, is not how big a venture fund should be. Nor the debate on how many VC funds is too many. The number nor the size truly matter in the grand scheme of things.
For an illiquid asset class like venture, where you’re betting on the size of the home runs, not one’s batting average, what you have to gain conviction around is:
How many truly great companies are there every year
How much capital is needed to get these companies to billion dollar outcomes
For the latter, there are two main ways to get to billion dollar exits: going public or getting acquired. And while there are outliers, the best way is for these businesses to get to $100M of recurring revenue.
And everything else is downstream of that.
As an LP once told me, “In the 1990s, it took $7 million to get to first revenue. In the 2000s and into the early 2010s, it took $700K. Now it takes $70K.” With each era and each wave of technological development, founders become more capital efficient. There are less barriers to get to market. Now with AI, it might just be $7K to get to first revenue, if not sooner.
The question is how much capital is needed to get to $1M ARR. If we take a decent burn multiple of 1.5x, then we underwrite an assumption that it’ll take $1.5M to get to $1M ARR. And possibly $4.5M to get to $3M ARR. And somewhere in there, that founder will find product-market fit and turn on the growth engine. CAC (customer acquisition cost) falls. And lifetime value increases. Payback periods shorten. And if all goes well, founders may find themselves with a sub-one burn multiple. And after they hit $1M ARR, and they triple the first two years, double the next three, they’re at $100M ARR. Of course, I’m illustrating the above all in broad strokes. The best case scenario. But most things don’t go according to plan.
Then an investor has to figure out if one should only make net new investments or re-capitalize a select few of their existing investments.
Then as LPs, what is the minimum ownership percentages that can return funds at each differentiated stage and fund sizes? And due for possibly another blogpost altogether, how does a 7-8x multiple on forward-looking ARR impact round sizes and valuations across bull and bear markets?
All this admittedly is both art and science. But I will admit that larger fund sizes and playing the AUM game may not be the answer.
In closing
My friend recently sent me this letter that Sam Hinkie wrote when he retired as GM of the 76ers. In it, he quoted the great Sage of Omaha when he closed down Buffett Partnership. “I am not attuned to this environment, and I don’t want to spoil a decent record by trying to play a game I don’t understand just so I can go out a hero.” And it’s for that same reason, Sam stepped down. The same reason Jerry Seinfield turned down $110 million to do another season of Seinfeld. Even though the sequel business does quite well.
There is no shame in knowing when to hang up the cleats. And there is great power in being disciplined. In fact, it’s one of the most sought-after traits in fund managers. If not, the most sought-after.
In VC, it comes in all sizes, ranging from:
Fund size discipline. There a lot of GPs out there who have gone on to raise 9- to 10-figure early stage funds. A mathematical equation that becomes increasingly harder to prove true, given outputs need to reflect inputs. In other words, larger funds are harder to return. There are a lot of VCs who would rather play the AUM (assets under management) game than stay disciplined on returns. Not just paper returns, but real cold hard cash. In the words of my friend Chris Douvos, “moolah in da coolah.” To quote another line from Chris, “OPM (other people’s money) is like opium. It’s addicting.” Something one too many investors have gotten addicted to.
Thesis discipline. As a friend who’s been a VC across multiple economic cycles once told me, it’s much better to turn down an off-thesis hot deal led by a top tier firm than to take it.
Career discipline. To echo the words of Sam Hinkie above.
And of course, knowing that we underwrite billion dollar outcomes, rather than trillion dollar ones. Then again, that’s just a subset of fund size and portfolio construction.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
There was a fascinating episode on the Tim Ferriss Show recently, where we get the inside baseball on how David Maisel, founder of Marvel Studios, raised half a billion on a promise for a company who’s public market cap at the time was only a fifth of a billion. Naturally, not only was he against a lot of headwind externally, but internally as well. According to the board at the time, they would only greenlight the idea of producing their own films (as opposed to licensing their IP out) if “Marvel had no risk. Not little risk, but no risk.”
On the cusp of Captain America and Thor being licensed away, David asked the board to give him six months. The “zero risk” pitch then came in the form of external funding, huge financial upside (if things worked out), market timing, and a promise.
Financial upside for Marvel
As David puts it:
“First to my board, the argument, was if we own our own studio, it means we get the full financial upside that they understood very well.” As opposed to licensing, their traditional business model. Where Marvel only got five cents on every dollar of profit. As was the case with SONY and Spiderman.
“Number two, we decide on greenlight when the movies get made that they also understood because they only sold toys really at the time, and the toys were contingent on a movie, which they then control the timing. Now when you’re doing a public company and you’re giving guidance every year, how can you give guidance if you don’t even know what movies are going to get made? And so controlling greenlight was important, full creative control.”
Moreover, the team was able to take 5% of revenues as the producer fee AND keep all non-film revenues (i.e. toys, video games, etc.). And even if four out of the five films lost capital, they’d still make $25M in revenue each. In other words, $100M in sum. Half of Marvel’s public market cap at the time. Whose cap was only based on toy sales.
Market timing
“The bond bubble of 2004 was happening,” as David shared, “so it was a time where there was loans being made that shouldn’t have been made. And a lot of people were enamored with Hollywood as they get enamored every few years.”
Zero downside
Instead of funding the studio off balance sheet, David would go out to fundraise from others. So what was the external pitch?
“Give me four at bats, and if one of them hits, then every movie’s a sequel after that.”
On top of all the above, to me, there were some interesting terms for the investment that helped sweeten the deal:
Merrill Lynch got a 3% success fee upon the $525M closing.
David got a low interest rate loan from Merrill by getting it insured by MPAC, therefore the debt became AAA debt, which “was easy to sell to pensions and easy to sell to individual investors” in case things went awry.
Now I’m not sure if this is standard Hollywood practice. But I imagine it’s not, at least back in ’03 and ’04. I’m a venture guy after all. And as one, the above is news to me.
That said, the banks David went to fundraise from were not taking equity. It was “pure debt. So very low interest rate. And the only collateral were the film rights to ten Marvel characters of which we could make for the movies.” Which, to me, ten characters sounds like a lot for a company whose business is characters. I also imagine these were characters that had some level of historical fanbase, so they weren’t random ones from the archives.
But David clarifies. “A lot of people misunderstand that they think we pledged ten of our characters as collateral. It wasn’t that at all because in the worst case scenario, it only got collected if we lost money on those first four movies. And then those six characters, we owned all the rights besides film. And if a film was ever made by the bank, whoever collected this collateral, we got the same license fee that we get if we just license it that day to a party. So there was no opportunity cost.”
And the promise
This is history now, but at the time, was a bold claim. The idea was borne out of frustration as an entertainment investor. That:
Marvel couldn’t capture a large part of enterprise value through productions with just licensing
The first movie business was horrible. Sequels, on the other hand, were a lot more predictable. So, the focus after the first movie would not be on predicting profit, but maximizing profit margins.
So David had a thought. “What if after the first movie, every movie after that was a sequel or a quasi-sequel, which required all the characters, or a lot of the characters, to show up in multiple movies?”
The idea of sequel snowballed into what we now know as the MCU — the Marvel Cinematic Universe.
Bringing it back to venture
It’s a nice corollary to raising a Fund I, where you’re also selling a promise. A world vision. A painting of the future. Nothing’s proven yet. You’re sure as hell not selling a repeatable strategy yet, and definitely not any returns. Since there’s a good chance you haven’t returned capital to LPs before.
And this is true for not just funders, but also founders. In the words of Mike Maples, “Breakthrough builders are visitors from the future, telling us what’s coming. They seem crazy in the present but they are right about the future.
“Legendary builders, therefore, must stand in the future and pull the present from the current reality to the future of their design. People living in the present usually dislike breakthrough ideas when they first hear about them. They have no context for what will be radically different in the future. So an important additional job of the builder is to persuade early like-minded people to join a new movement.”
Dissent is a luxury
The truth is loads of people will disagree with you. You’re not looking for consensus. In fact, it’s better to be wrong and alone than right and with the crowd if you’re in the venture world. Either as a founder or an emerging GP. It’s something I recently learned from the one and only Chris Douvos. If you imagine a 2×2 matrix… On one axis, you have right and wrong. On the other, you have with the crowd and alone. You want to be in the right and alone quadrant for sure. That’s where “fortune and glory” exists. It’s where alpha exists. It is how you become an outlier and achieved outsized returns.
But the prerequisite to be there is to have the guts to start in the wrong and alone quadrant. If you start from being right and in the crowd, you’re one among many. And that doesn’t give you the liberty to have independent thinking. You’re constantly trapped in noise.
It’s as Abhiraj Bhal says. “If you are a category-defining company, you will always have a TAM question, if the category is defined by somebody else, you will not have a TAM question.” You want people to question you. And as humans, we like to fit in. But to create something transcendent, external doubt is your best friend.
As such, your promise of the future must seem bizarre.
Don’t start with the product, start with your customers
When you have a promise, admittedly, the easiest way is to start engineering it right away. Without market validation. Without stress testing. Which pigeonholes a number of founders. I forgot the origination, but there’s a great line that says, “The only difference between a hallucination and a vision is that other people can see the latter.”
And in order to test that, you need to get in front of potential users and customers first. Max, someone I had the joy of working with, once wrote the below timeless tweet:
My hot take of the day:
Most aspiring startup founders who think they should learn to code would be better off learning to write well instead.
As Elizabeth once shared: “We decided that we’d start with no product. We would not build anything. And, we just started selling ads. We manually brokered deals with publishers and advertisers and took a cut in between. We got our customers by emailing people and setting up the copy and links ourselves. People would pay me through my personal PayPal account. It was only when we realized we were onto something that we started building technology to remove bottlenecks.”
On the investor side, it’s building a thesis where great investments fall into. It’s a way of looking at the world in a perspective that may seem foreign to others, but almost obvious in retrospect. The thesis should elicit the response, “Why didn’t I think of that first?” But no matter how obvious, you are the best positioned to bring the thesis to life. That doesn’t mean you need returns yet. Although good graduation rates certainly help as a leading indicator.
In that regard, it’s quite similar to how David Maisel foretold of the Universe to come. Obvious once explained, yet still met with resistance from legacy players.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
