A few years ago, in one of my favorite coffee shops on 7th Street in San Francisco, over a vanilla cold brew, a then 25-year old founder told me that he had recently taken his then-first vacation in five years. Took a full week off. Didn’t touch work at all. And just enjoyed it with his fiancée. But contrary to what one would expect, his body language that seemed to indicate the exact opposite of having a good time. Two hands cupped over his face, as he slowly dragged them both downwards in exasperation. Followed by many sighs.
He shared that in the time he was gone, the website crashed and the team had trouble bringing it back online. And when they finally did bring it back online, they were waiting for his approval to move forward. As such, didn’t bring it back online until he came back. With another large sigh, he went on to say that he’d never take another vacation ever again.
Running your own business is tough. Really tough. I get it. If you’re the founder, it’s your baby. And sometimes, it’s really hard letting go on what may seem like key decisions. Eventually, that becomes a slippery slope where I see too many founders needing to control every decision that goes on in the company. And even if you hired extremely well, you’ve capped your team’s potential by not letting them execute to their fullest capacity.
In the above dilemma, as you might know, it’s not a to-vacation-or-not-to-vacation problem. It’s a you-need-to-give-your-teammates agency problem. And it might seem obvious to you and me, to any third party observer. But it wasn’t to him. He was so frustrated that he was focused on the one new thing he did and believed that one new thing had a causal effect to a problem that was looming over his team’s head for a long time.
It is true that we are products of our scar tissue, but quite often, in an attempt to not be in the same situation again, people overcorrect. They take then run with the seemingly most extreme “solution.”
And in the times scar tissue start to form, start from first principles. Is taking a vacation really the biggest offender? Do great CEOs just not take time off? Is there something else that I’m not willing to admit about how the results played out?
What am I assuming to be true that may not have to be true? What are the raw facts, stripped of opinions and speculation?
Why was my team incapable of making that decision? Was it something that I told them before or did before that has since prevented them from making calls? What do I spend most of my day doing? Can I outsource some of my tasks? Some of my decisions? How would I do that? And only then, can I ask myself and others: what can I do from now on so that history doesn’t repeat?
Seeking and redefining excellence
And once you’re at the root of the problem, find others you admire who run organizations you admire.
Excellence is an interesting concept. One of the few words out there where its definition changes over the course of your life.
It’s one of the few words where it is not only different for every person, but that even within each person, every time you see something excellent, it sets a new bar and stretches that definition. Defined by only the most excellent thing you’ve seen.
The truth is that most great lessons happen to err on the side of examples. So to have people who define that word for you again and again are the “Sensei-s” you want in your life.
So spend time with others. Notice how they approach problems. And stretch your definition of excellence.
For the 25-year old founder who hadn’t worked any other job in his life, and only his own, there’s immense value in learning from others and building expertise at high-growth institutions. Or with people who you deeply respect.
Asking for the lesson
Tim Ferriss, on a recent episode with Noah Kagan, said, “Life punishes the vague wish and rewards the specific ask.” And I frickin’ love that line.
Be specific. No picking brains. You’re not a zombie or a vulture or a crow.
Not 30-minute coffee chats. Those quickly become recipes of asking for too much time with an amorphous ask. To a busy person, that 30-minute ask sounds like a recipe for losing 50 minutes to an hour of your life you can never get back. Including travel to and from. Time, as the only unreplenishable commodity, is precious. As Howard Lindzon said on the Superclusters podcast, when we’re young, we’re time-millionaires, but over time, we get poorer and poorer. We then become time-thousand-aires as we age. And eventually, we run out of temporal capital.
It is in times of need and struggle, that we often have the most prescient and specific ask to make of potential mentors.
“When in X situation, and after having Y results, my gut seems to tell me to do Z, but given that you’ve experienced these situations before or have likely seen these situations unfold, am I directionally accurate?”
In closing
There’s a lot of this hustle porn in the Bay Area. Loud claims of not taking any vacations or sleeping only three hours per night. Moreover media perpetuates and lionizes this way of living.
It’s not true. Science shows we do much better with eight hours of sleep. It shows that every so often, we need to take time to unwind, so that we can come back to be more efficient and inspired than before. You can clock in the hours, but that doesn’t mean you are producing quality in a one-to-one capacity.
And I worry that like the founder that took his vacation for the first time, then overcorrected, we live in a society where we’ve forgotten that we’re human. That we need breaks. That we need sleep. And that we can’t do most things alone, including building ambitious ideas and maturing as professionals.
#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.
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.
Guilty as charged, but I was doom-scrolling on Instagram recently and I came across a reel where two Formula 1 drivers were asked to guess the race track given only a racecar’s engine’s audio (vroom vroom). And to my absolute amazement, the two were able to guess track after track. Some answers seemed to have only taken them a few seconds to figure out.
The Instagram reel came from this YouTube video for those who are curious.
So I couldn’t help but notice, how well they knew each track. That they had taken special notice to all the small bumps in the road. The turns. How long each turn was. All of it, without any visuals. It’s for the same reason I am always impressed everytime Bon Appetit’s Chris Morocco can recreate dishes by taste, smell and feel alone (no sight, he’s blindfolded). A lot of which is in line with the post I wrote last week. It’s not just about paying attention, but how to pay proper attention.
So this time around, I thought why don’t I bring this into the world of events. Something I’m deeply passionate about.
Experiences > Events
“Jonathan Yaffe, co-founder of the experience management platform, AnyRoad, defines an experience as something that stimulates at least three senses.”
I first read that line on page 146 in my buddy Lloyed’s book on community-building. And it made total frickin’ sense. Lloyed went on to write that Zoom sessions don’t count as experiences because it only engages one’s sight and sound. But events like Dining in the Dark, which my friend hosts, do count. Despite taking away sight, you’re tapping into taste, smell, and sound. The last of which occurs when there’s a band playing in the background, but with each course, a new instrument is added into the mix. And it’s because of experiences like these, they leave such strong impressions. Emotional impressions. Nostalgia.
Emotions, after all, are multi-sensory. And eliciting those emotions require you to fully commit. The question is how.
How to make people feel special at events
One of my favorite lessons I picked up during my time at On Deck was from Sam Huleatt. A strike is better than a spare. We were hosting sessions and events three to six times a month, depending on the time of the year. And Sam proposed that we go through an exercise. A thought experiment.
What if we only did one event per month? If so, what would that look like?
What if we only did one every quarter?
And what if we only did one every year?
How does that change the way we think about events? What changes at each stage?
Honestly, one of my favorite exercises to go through when I feel compelled to hit a certain quantity and realize I have to find the optimal point between quantity and quality.
But since then, that inspired another set of thought exercises I do.
If I had to host an event for just one person — just one — what would I do to make it an unforgettable experience?
What would need to change if I did so for a four-person dinner?
A six-person dinner?
What about a 10-person event?
What about for 50 people?
For 100?
For 1000?
And so on.
At some point, usually around 50 is when things start hitting scale. But let me break down why each of the above before 50 are inflection points:
1 person. This person is your universe. You can’t make it any more tailored and personalized than this. It’s a date.
4 people. For the most part, still only one conversation happens at a time, but now as the host, you have to make sure no one is left out.
6 people. In my mind, this is the minimum number of people for more than one conversation to be happening at once. For the first time, you have to worry about flow of the event while you’re not capable of being present everywhere all at once.
10 people. You not have more than two conversations going on. Juggling with two is easy; for some, that may not really be juggling. But once you’ve added a third and a fourth ball, then this is real juggling. Here, the host has to think not only about the number of conversations, but to pay attention to folks who become satellites to conversations. Watching for people who are distracted. Uncomfortable. On their phone. And so on. But also, when conversations go too long. As the host, finding ways for people to enter and exit conversations easily is vital. It’s better to have less time than to have too much time.
And 50 people. For the first time, you need to think about having more than one host. You can only scale your time and attention so much. So now you’re training a team to be as attentive, if not more, than you are.
The larger the event, one can say the more polyamorous you have to be. You have to deeply care for each person. And while everyone at your event likely knows you’re “dating” everyone else, if you can still make them feel special — like the most important person in the world, that their time is valued, their attention is valued, and their presence, mind and insights even more so — then you’ll have done something 99.9% of event hosts have not been able to do. Frankly, probably would rather not do. ‘Cause, at least if you start small, it’s not crazy work. It’s quite easy, just requires more effort than most are willing to give.
Other times, event hosts just scale their events too quickly. And hit scale before they find their magic. So, if you can, do unscalable things before you hit scale.
Notice when in a conversation someone’s eyes divert. Notice when they ask to leave to use the restroom. And notice when people lean in to a conversation, as opposed to lean back. Just like a racecar driver notices how many seconds a turn is, when there’s an indent in the road, when the brakes are glazed and the tires need to warm up without having to look at them.
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.
Recently, I’ve been chatting with a number of GPs and LPs looking to make their first hires. Many of whom hadn’t built a team prior. Now I’m no expert, nor would I ever claim to be one. But I’ve been very lucky to hire and work with some stellar talent.
They asked me how I think about interviewing, selecting, as well as onboarding. I’ll save the last of which for a future blogpost, but for the purpose of this one, if you frequent this blog, you’ll know I love good questions. And well, I get really really nerdy about them. So, as I shared my four favorite, nonobvious interview questions as of late with them (some I’ve used more than others), I will also share them with you.
I won’t cover the table stakes. Why are you excited to be here? What skills are you a B+/A- at? And what are you A+++ in? Why you? Etc.
If you had to hire everyone based only on you knowing how good they are at a certain video game, what video game would you pick?
I recently heard Patrick O’Shaughnessy ask that question to a guest on his podcast, and I found it inextricably profound. While the question was directed at Palmer Luckey, who has a past in video games, the words “video game” can easily be replaced by any other activity or topic of choice and be equally as revealing. Be it sports. Or an art form. Or how they grasp a certain topic. Even, putting them in front of a Nobel Prize winner and see how quickly they realize they’re in front of one.
The last example may be stretching it a bit, but has its origin in one of my favorite fun facts about the CRT — the cognitive reflection test. Effectively, a test designed to ask the minimum number of questions in order to determine someone’s intelligence. But in a parodical interpretation of the test, two of the smartest minds in the world, Daniel Kahneman and Amos Tversky, decided to make an even shorter version of the test to measure one’s intelligence. The test would be to see that if one were to put you in front of Amos Tversky, one of the most humble human beings out there despite his intelligence, how long it would take you to realize that the person sitting across from you was smarter than you. The shorter it took you, the smarter you were. But I digress (although there’s your fun fact for the day).
The reality is that any activity that requires a great amount of detail, nuance, resilience, frustration and failure probably qualify to be mad-libbed into that question. Nevertheless, it’s quite interesting to see what someone would suggest, and a great way of:
Assessing how deep a candidate can go deep on a particular subject,
How well they can relay that depth of knowledge to a layperson, and
How they build a framework around that.
I hate surprises. Can you tell me something that might go wrong now so that I’m not surprised when it happens?
Simon Sinek has always been one for great soundbites. And the above question is no exception. It’s a great way of asking what is one of your weaknesses. Without asking what is your weakness? Most, if not all hiring managers are probably accustomed to getting a rose-tinted “weakness” that turns out is a strength when asking the weakness question to candidates. It is, after all, in the candidate’s best interest to appear the most suitable for the job description as possible. And the JD doesn’t include anything about having weaknesses. Only strengths… and responsibilities.
At the same time, while the weakness question makes sense, when there is an honest answer, I’ve seen as many hiring managers use the associated answer to discount a candidate’s ability to succeed in the role, before given the chance. While this is still throwing caution to the wind, for one to be open-minded when asking this question, at the very least, you’re more likely to get an honest one. At least until this question becomes extremely popular.
Another version, thought a lot more subtle, is: What three adjectives would you use to describe your sibling?
I won’t get into the nuances here, but if you’re curious for a deeper dive, would recommend reading this blogpost. The TL;DR is that when we describe others (especially those we know well), we often use adjectives that juxtapose how we see ourselves in relation to them.
What did you do in your last role that no one else in that role has ever done?
This is one of my favorite professors, Janet Brady’s, favorite questions, and ever since I learned of it, it’s been mine as well. Your mileage may vary. Of particular note, I look for talent with entrepreneurial natures to them. Most of what I work on are usually pre-product-market fit in nature. In other times, and not mutually exclusive to the former, requires us to re-examine the status quo. What got us here — as a team, as a company, as an industry, or as a citizen of the world — may not get us there.
And there is bias here in that I enjoy working with people who push the boundaries rather than let the boundaries push them. And I love people who have asked the question “What if?” in the past and has successfully executed against that, even if it meant they had to try, try again.
What haven’t you achieved that you want to achieve?
Steven Rosenblatt has always been world-class at hiring. By far, one of the best minds when it comes to scaling teams. For a deeper dive, and some of his other go-to questions, I highly recommend checking out this blogpost.
When you’re building a world-class team, you need people to self-select themselves in and out of the culture in which you want to build. Whether it’s Pulley’s culture of move fast and ruthlessly prioritize to build a high-performance “sports team or orchestra” or On Deck’s non-values, it’s about making it clear that you’re in not because you’re peeking through rose-tinted glasses, but that you know full well, that you will be confronted by reality, yet you still remain optimistic. To do that, you need:
A tight knit team who hold the same values
And folks with a chip on their shoulder
The latter is the essence of what Steven gets at with the above question. And does one’s selfish motivation align with where the company wants to go and what the role will entail.
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 first heard this question from Morgan Housel quoting a Navalism (for the uninitiated, that means has its source tracing back to the one and only Naval Ravikant). And it makes you think, that in the multiverse, where each version of you lives a different life and makes different choices, what would stay constant?
These are things that are not attributed to luck. And as Morgan mentioned, “those are the things you want to focus on in life.” When predicting the future, many try to predict what will change, but the best bets with long time horizons are on those that don’t change. Things that aren’t attributed to luck. Or chance. In this world we live in, you’d be quite surprised the number of small, accidental decisions we make that lead to life-changing events.
Like you being 10 minutes late to a party meant that you somehow just showed up at the same time as your future spouse. And it was because of that, that led you to have a two-hour long conversation with him/her. Otherwise, you’d have spent the entire party hanging with your college friends.
Or because you forgot to bring your umbrella on a day it rained, it made you run into a hotel for shelter, where you stumbled upon the investor who led your Series A round. Because he/she too forgot to bring an umbrella.
Of course, I could play hypotheticals forever. Although I find it’d be a fun exercise to really examine how much of your most life-changing moments were due to serendipity.
As someone who makes their living on attempting to predict the future, that means we have to go back to first principles. For instance, human nature. Reid Hoffman’s framework that all great consumer products tap into one of the seven deadly sins. Something that despite innovation is timeless. Anecdotally, I do find some of the greatest investors — LPs and GPs alike — to be avid students of history, philosophy or psychology.
“Email is a wonderful thing for people whose role in life is to be on top of things. But not for me; my role is to be on the bottom of things.”
In life, while catchy and interesting and the talk of the town for that brief moment, sometimes it’s better to get to the bottom of things than to stay on top of things. After all, you only have so many letters on your tombstone.
The DGQ series is a series dedicated to my process of question discovery and execution. When curiosity is the why, DGQ is the how. It’s an inside scoop of what goes on in my noggin’. My hope is that it offers some illumination to you, my readers, so you can tackle the world and build relationships with my best tools at your disposal. It also happens to stand for damn good questions, or dumb and garbled questions. I’ll let you decide which it falls under.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
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.
One of my recent favorite soundbites is Rich Paul‘s. For the uninitiated, he’s the agent behind LeBron James and Draymond Green. And in his recent Tim Ferriss episode, he said: “Some people define the business card and some people are defined by their business card, and so I don’t carry a business card.”
Some of the most exciting conversations I’ve been having as of late have been in the world of family offices. There’s this shift in generational wealth transfer, but often times without sufficient knowledge transfer. At the same time, there are many next gens leaning more into risk and philanthropy. Many want to increase their exposure to venture and private equity as an asset class, but are still learning how to underwrite such risk.
My conversations echo a lot of what Citi’s been seeing as well. Two in five family offices wanted to increase their exposure to illiquid asset classes, namely the PE and VC asset classes. And while many bucket VC and PE in the same asset class, the truth is the assets operate very differently. Even within venture, underwriting the risk and performance of a sub-$40M fund versus a $40-100M fund versus a $100-500M fund versus a $500M+ VC fund are completely different. Some LPs may disagree on the exact benchmarks (for instance, sub-$100M funds and everything else), but the reality of assessing an emerging manager and an established manager are different. But I digress.
The rest are either rebalancing or figuring out their re-up strategy. Yet, as I’m sure GPs are seeing today, that shift in strategy, requires time, research, and confidence before family offices can pull the trigger. Many are waiting to Q1 next year, but engaging in conversation today.
I’ve also written before about one of my favorite lines from Engineering Capital’s Ashmeet Sidana, “A company’s success makes a VC’s reputation; a VC’s success does not make a company’s reputation. In other words to take a concrete example, Google is a great company. Google is not a great company because Sequoia invested in them. Sequoia is a great venture firm because they invested in Google.”
And I’m seeing a similar vein with family offices. The next gen don’t want to be defined by their predecessor’s goals and records. They want to define their own legacy.
There’s also the saying: If you know one family office, you only know one family office. So any broad-stroke generalizations are loosely correlated at best. That said, anecdotally, having talked with about a hundred or so family offices, here’s what I’ve come to notice.
My crudely drawn 1D scale of whether venture capital is an asset class or an access class
Smaller and/or emerging LPs see VC as an access class. Larger and more sophisticated and established LPs see VC as an asset class.
The Mendoza line — the line that separates the emerging LPs from the established ones —seems to be around 20-30 managers or over 6-7 years of venture data. For the latter, that means, you’ve seen Fund I’s and II’s graduate to Fund III’s and IV’s.
So the question for many of the next generation leading family offices has flipped from: Are you defined by your surname? To: Do you define your surname?
For those that pursue the latter, they’re a lot more proactive than previous generations. They participate in communities. Go to events. Seek education on the matter. Network with their existing managers to discover new ones. Some have also built covenants to co-invest in their manager’s breakout winners. Quite a few are building emerging manager programs or would like to. They’re hungry. Hungry to learn.
The problem I’m seeing with many managers is that they’re seeking transactional relationships. The urgency to get to their first or final close leads them to optimize for LPs who can close fast. And I get it, that’s been the game historically. But it’s leaving a massive opportunity in the market for those who have the time and are willing to educate their and prospective LPs. Who are willing to spend time building a relationship through giving first.
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.
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.
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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.
