What do LPs Want to See? A Peek into the World of a VC fund of Funds
Times are pretty good in venture now. Not only did fundraising by U.S. startups hit a quarterly record of $28 billion in 3Q 2018 according to the latest MoneyTree report, M&A activity has been very robust and the IPO market has opened in a big way with numerous IPOs of VC-backed companies over the past year and half including Spotify, Adyen, Farfetch and DocuSign, among others, and there are many more in the pipeline.
It is not only the large, high-profile VCs that are benefitting from this strong momentum; micro VC funds (classified by PitchBook as sub-$50m) are too. According to PitchBook, in each of 2017 and 2016 micro funds raised $2 billion in aggregate and 2018 is pacing for record value with $1.1 billion already closed in the first half of the year.
As a fund-of-funds, we are feeling these trends first hand at Vintage, too. We, as well as other institutional VC fund investors are inundated with new fund pitches. In fact, we often joke that fund formation seems to be higher than company formation! However, we aren’t complaining.
We, too, are long venture and appreciate that technology no longer represents a particular sector in the economy as it may have been viewed in the past, but is rather an enabler (and disrupter) of huge markets such as financial services, consumer goods, energy, travel, media and more. In fact, investing in venture is all we do at Vintage and we’ve raised several venture-focused fund vehicles over the last 15 years and seek to partner with our managers over the long-term, through both up and down markets.
Moreover, we see the advantages of investing with new and emerging managers, and in fact have a dedicated emerging managers allocation. However, with the explosion of new managers on the market, although we review each new opportunity carefully and seriously, we do pay more attention to some than others for specific reasons. In a series of short posts, I thought it might be helpful to provide some pointers to emerging managers on which traits grab our attention more than others as well as share some best practices from our 15 years of experience investing in VC funds.
Before starting, it’s worth mentioning that investing in emerging funds is similar to investing in startups. In fact, an emerging fund is essentially a startup. The only difference is that this startup invests in other startups, rather than developing code to disrupt, say, the insurance industry. That’s an important framework to keep in mind as you go about fundraising. Think about some of the things you look for when you are pitched new ideas and apply those to your own fundraising practices.
Your Unique Selling Proposition
The success that emerging and micro VCs have had in fundraising means that there are a lot of active managers out there at the pre-seed and seed stage, which means you likely have pretty stiff competition. That, in turn, means you need to have a very convincing argument as to why you believe the best founders will call on you to invest, as opposed to reaching out to the other hundreds of emerging VC funds (and don’t forget about the larger brand name VCs that still do seed…), when they begin working on their new venture. LPs such as ourselves need to gain comfort that you have built that strong enough USP to ensure strong deal flow and access.
In short, we are looking for a compelling story — a truly differentiated proposition, the secret sauce or the unique angle that will provide you with access to the next great venture outcome. That is not trivial!
The good news though is that this uniqueness can come in many forms.
For example, you may have created a highly-regarded community or platform in a particular vertical, thereby creating a “go-to brand” and as a result gaining proprietary access to promising founders and fund relationships. One example is LDV Capital, a NYC-based seed fund investing in vision tech startups. LDV has created a strong platform thanks to its well-known annual summit attracting hundreds of founders, investors, experts and academics to discuss all-things visual tech as well as its monthly dinner series. Platforms such as this can provide managers with an unfair competitive advantage for deal flow and diligence.
Another angle could be investing in less crowded markets than Silicon Valley, looking for under the radar opportunities in an undercapitalized, yet exciting, emerging tech hub with an aim to become the go-to fund.
For instance, Seattle is a fast-growing city driven by exceptional momentum from local tech giants such as Amazon and Microsoft. The city is also home to engineering centers for major tech companies, including Adobe, Dropbox, Google, Lyft, Oculus, Oracle, Pinterest, SAP, Stripe, Twitter, Uber…and the list goes on, thanks to world-class research and education institutions. As a result, Seattle has grown to become a center of excellence for cloud, ecommerce and ML, yet despite this there remains some dependence on out-of-town investors. So we think a local emerging manager, such as Pioneer Square Ventures, with strong local and cross-country networks as well as prior investment experience, is on to something interesting.
We have also seen successful tech founders as well as senior operators from large tech companies raise funds in order to attract entrepreneurs seeking the domain expertise, networks or other unique value-add they can provide. Afore Capital is one pre-seed fund based in the Bay area that comes to mind. In their past, the Afore team were senior product managers at Twitter and Google, and they now leverage their backgrounds and networks to invest in product-driven teams at the earliest stage. Their broad advisory board comprises experienced product heads from consumer tech companies, who can be helpful with deal flow and advice at the portfolio company level.
Of course, there are many other ways that managers may position themselves as sought-after by great founders and these are only a few examples. Bottom line, it is worth spending a lot of time thinking this one through well and making sure you are truly unique before going out to institutional LPs with your new fund. When Vintage commits to a new fund, we do so with a view of investing with that manager over several fund cycles, so we need to really gain comfort on this point…and it is likely the first question you will be asked!
In our next post, we will touch on some of the other issues we spend time looking at when meeting emerging managers.
Yonah Monk is Principal at Vintage Investment Partners, where he has been since 2012.