Four things every VC manager should know before starting their first fund
Alex Di Santo (pictured), group head of private equity at Crestbridge outlines four considerations for venture capital managers looking to launch their first fund.
Articulating your differentiators will help you gain attention from higher quality investors
There’s a finite pool of investors and there are thousands of VCs in the market: far too many for even the large institutional investors to process all of them. The best way to stand out, is to think about what your unique selling point is, before you launch your fund.
“How are you different?” is a question that investors, founders, employees and other partners will all ask you before becoming involved. “Prior track record” is a great answer to have, but it shouldn’t be the only answer you have – and what if you’re a first-time fund? The most successful VC managers will be able to answer this in a meaningful way.
Some good differentiators for successful VC managers have included cornering a particular sector, theme, vertical or geographic focus. Focusing on some sort of niche not only helps investors understand how you’re differentiated but it can also make you the first port of call for quality start-ups in your target area. Research shows that success breeds success for VC managers, so this will become a virtuous cycle: investing in higher quality start-ups means better returns, which then allows you to attract better investment terms from a wider range of investors.
The chart below explores some examples of some of the best-known VC managers and where their differentiators are (excluding prior track record):
Understand which investor audience you should be targeting
Who are the investors most likely to invest with your fund? The two most pertinent points that will determine the answer to this question is, how big is your fund going to be and what is its differentiator?
On the point of size, large institutional investors are unlikely to allocate USD25m to your USD50m fund for two reasons: the investment size is too small for them to be interesting, and they would own too high a proportion of your fund (50 percent) to be a sensible investment for them.
If you’re launching a first-time fund, it’s even less likely institutions will be able to invest with you, as their own mandates may disallow this. All of this means managers of a first-time VC launch under USD50m should be thinking about targeting family offices and ultra high net worth investors (‘UHNWIs’), rather than targeting a group of individuals who cannot invest with you in the first place.
The second element to consider when approaching investors, is around your differentiator. When you’re setting your fund’s investment thesis or focus, think about investors that align with your vision. For example, if you’re launching a life sciences-focused fund, look out for family offices, endowments or angel funds with a life science focus themselves.
Creating a list of your top 100 investors, clearly highlighting the synergies between what they and your fund stand for, will ultimately reflect well, and work better than mass-emailing a thousand investors who may have little to no interest in your area to begin with.
The average investor adds very few new managers to their VC portfolio in any given year, so standing out and focusing your time on the right investor for your proposition is vital.
Think about your partnerships with investors and service providers carefully and consider what “extras” they can bring to the table
Investors may be able to bring something else to the table beyond capital, for example, a family office investor with industry specific expertise could be a very helpful advisor if you share a niche. Speaking to other companies in the investor’s portfolio may also shed light on some helpful extras these investors can provide. If they’re making an investment with you, they are also incentivised to help you.
Service providers can be viewed the same way. Beyond the service you purchase from them directly, they may be able to help in other tangible ways. Some fund administrators, for example, help by reducing fees for first-time managers or providing them free access to coveted office space with a prestigious address. The venture capital ecosystem is well networked, so they can also introduce you to important contacts: whether it’s an investor, the chance to work with a third-party who could enhance your proposition or provide useful endorsements for your fund in the future.
It's also important to learn from others
The following examples demonstrate why the right team, philosophy and process can spell the difference between success and failure:
Social Capital, alongside other “change-the-world-funds”, were all too ready to part with vast sums of capital in order to be the first investors in new age tech businesses with socially orientated goals. Social capital aimed to ‘fix capitalism … it is inherently numerical, and as a result, it is inherently objective’, according to its founder.
As founders weaved beautiful narratives of how and why they founded companies, similar aged (and often experienced) investors bought into it, both mentally and financially. Intrepid LPs lowered their guard and took unprecedented risks to be the first investors in these pioneering companies.
However, Social capital began drifting away from their core mission and the strategy became more that of a traditional investment firm. The subtle transition away from this disruptive venture may have been the catalyst for a mass exodus of employees in 2018 and its ongoing decline since.
The lesson? Team is everything. Stick to the philosophy and strategy your team has bought into and be willing to invest and take them with you on your journey.
Formation 8 was another example of a smart enterprise looking to mold the future through investment strategy, and with the largest debut fund in venture history (USD448m) it seemed there was a strong possibility of the firm achieving its objective. With a total of USD1.39bn raised before their collapse and successful investments into Oculus, Slack and other tech start-ups all seemed positive.
However, under the surface all was not as it seemed. A large rift had grown between founders Joe Lonsdale and Brian Koo. They disagreed on investment strategy and even the geographical location of the Formation 8 offices. Adding to the fire, Koo then tried to open up a restaurant in Palo Alto, which Lonsdale took exception to.
Eventually, the two founders went their separate ways and Formation 8 was disbanded. The lesson again is not to rush. These two relatively experienced venture capitalist fund managers ceded their jobs and combined forces in an attempt to seize the social tech movement in its nascent stages. They had raised USD448m before an agreement on investment strategy or office space had been put down in writing… They were the first in and the first out.
Jawbone, a consumer electronics company, is an example of venture capitalists causing their own downfall due to “death by overfunding”. Despite millions of dollars of investment, and a market valuation of USD3.2bn, the company began liquidating proceedings in June of 2020.
The race by venture capitalists to invest in tech, primarily based in Silicon Valley, has caused many to over invest in unproven firms, having performed too little due diligence. Jawbone laid off 15 percent of its staff in 2015 and yet still investors proceeded to invest USD165m, alongside the sovereign wealth fund, the Kuwait investment Authority (KIA).
While Jawbone competitors, such as FitBit, stormed ahead, investors looked to invest more in Jawbone to boost performance. Nonetheless, this sort of momentum trading is often a curse in disguise of a blessing. Ironically, had Jawbone kept investment lower and subsequently its valuation, it would have remained a more sustainable and healthy acquisition target for investors.
The lesson for venture capitalist fund managers is not to get blindsided by the substantial amounts of capital being invested in tech, especially US tech, and remain cautious and due diligence heavy. While there are many successes in the tech economy, big-ticket failures are not unheard of.