The number of firms investing in early-stage companies in the Midwest increased by at least 1 this summer. Here’s the story of the youngest and scrappiest micro-VC firm around.
My partners and I (and by partners I mean: my dad, my father-in-law and my cousin) created M25 Group in May, and since then we’ve invested in a handful of startups.
As the managing director, I oversee dealflow, analyze the best opportunities, and recommend the most compelling for investment, (we poll the group — everybody gets 1 vote). They’ve all got their own companies to run, though somehow they still manage to put in several hours a week with high-quality business advice and assistance in vetting companies and the endless web of networking. In addition,they’ve contributed a significant portion of their money towards the firm — which further backs up their faith in my abilities. Together, they have $1M in Fund #1, and are prepared to double-down (or quadruple…) on a ~$10M Fund #2 alongside outside investors.
Now when I tell most people about M25 Group, they rarely respond with skepticism — most people are just too polite. But in the back of their mind, I know they have to be thinking the same cynical thoughts I’ve had.
“Oh great, another ‘unique’ approach to venture capital.”
“What makes you think you can choose the best companies?”
“You guys have absolutely no experience in this space.”
Or maybe even “This is the height of the bubble and there’s already too much money in this!”
And definitely “You’re only 23…”
I feel like I should respond to those doubts. But some of those points feel like the standard “deal-killers” investors dish out to startups they’re evaluating when they are looking for a way not to invest. “Why couldn’t Google just build this instead?” or “It would’ve been built already if it was a good idea” or “There’s no IP — it’s not defensible.” Instead, I’ll just tell you our strategy and let you judge for yourself — for the skeptics out there, it will just give you more fuel for your fire, but for those willing to give us a chance, I think you’ll get something out of it.
M25 Group’s Strategy (numbered just for easy reference, not by importance):
1. Scale dealflow
I don’t know anyone who would really disagree with this one. We want to see a lot of deals. The more deals we see, the faster we can deploy our capital in high-quality startups. The bigger the top of our funnel is, the bigger and better the bottom of our funnel can be.
How are we doing this? First, we’ve joined two angel groups: Hyde Park Angels in Chicago (with a Midwest focus) and VisionTech Angels in Indiana. By joining them we get the benefit of having hundreds of deals a year hit our pipeline which would be very difficult for us to do on our own (see point #7 about being scrappy).
Second, I’ve reached out to a lot of our growing pool of connections to establish a consistent back-and-forth of deal-flow. I send fellow early stage investors I trust a summary of the deals I am going to invest in. Often they send me startups they like as well. But it’s not just fellow investors that send me deals — once word gets out that you’ve made some early-stage investments, it seems like almost everybody knows somebody who’s starting a company. I don’t mind — send ‘em all to me and I’ll be sure to take a look.
Third, I’m working on growing our connections with a main source of talented entrepreneurs — universities and accelerators. Right now I’m looking at deals from a handful of large Midwestern universities and am actively involved with a few accelerators. Sometimes these entrepreneurs are in an earlier stage than we would invest in, but I am more than happy to help guide them and form a relationship with them early on.
2. Only invest in the Midwest
There’s a lot to love happening on both of the coasts (and Colorado, Texas, Europe, etc.) but we don’t do that. Why? Well there are a number of interconnected reasons. First, if there is a bubble it’s likely not going to hit the Midwest first or hardest. Second, valuations here have stayed more reasonable and the amount of VC capital hasn’t skyrocketed. Third, we also feel like our capital is more “needed” in the Midwest and we want to have a direct impact in our region (a.k.a IMBYism). On top of all that, we like to have an in-person connection at least once before investing, and with our check size it wouldn’t make sense to fly out to San Francisco.
There are also a lot of practical reasons to start a business in the Midwest which directly aid them in becoming more investable. Most of these reasons have already been underscored by prominent Midwest VCs: affordable cost of living, easier tax code & regulation, large amount of Fortune 500 companies, and impressive talent pool from universities.
3. Early-stage rounds only
We don’t limit ourselves to early-stage rounds because we don’t have enough opportunity or capital to invest in later rounds (through our angel groups we actually receive plenty of opportunities). Instead, it is because we aim to get the highest IRR possible, and this type of early-stage investing has been shown to produce returns in the range of 25%-30%. What do we define as early-stage? Well, we aren’t going to participate in your friends and family round (even if I am your friend or family) because there is absolutely nothing with which to evaluate your company at that stage. But we can go in pre-revenue — we just want to see a clear path to revenue. If I had to put a number on it, I’d say the rounds we like to be in are between $500K-$1.5M.
And what about follow-on? We’ve reserved 30% of Fund #1 for follow-on rounds, though our final strategy is still being tweaked and could certainly be significantly different for Fund #2. In general, much of the research I’ve done regarding follow-on rounds indicates a lower return, though I’d love to hear of others’ opinions and results to further shape our strategy. Right now I think we will have a limited approach to follow-on as the opportunity cost (particularly, how follow-on would limit our ability to invest in new startups) appears too high.
4. High quantity & quality of investments
Several analyses and Monte Carlo simulations have been run on early-stage investing and they all point to one thing — the more investments you make, the more likely it is that your portfolio is profitable. We at M25 Group are big believers in portfolio theory, and have shaped our strategy around a high number of quality investments.
For Fund #1, we aim to do at least 20 investments, all of roughly equal size. We recognize this is on the lower end for recommended quantity, but with the size of Fund #1 we felt a higher number would dilute our standard initial investment amount too much. For Fund #2, we aim to do at least 50 investments, with the possibility of doing up to 100.
We also aim to have the quality of each investment as high as possible, though you’ll quickly find that after a startup reaches that high bar of “investability”, seasoned investors disagree and the game becomes quite subjective. Even the best startups were often passed over several times by the best VCs, and some of the biggest failures were viciously fought over on Sand Hill Road.
Long story short? We aim to invest after the startup has met that high bar of investability. We realize there will be countless exogenous factors causing that startup to fail or succeed, but we trust in our portfolio size to tease out the “luck” variable and ensure us that amazing return.
5. Passive investments
Because of our small check size and our limited amount of time for each startup (we are trying to invest in 20 startups in a year after all), we can’t be the lead investor. What this allows us to do is let the bigger (and more experienced?) investor do his part to ensure the company’s success and for us to only add value when needed. Are we freeloading? No — we are still providing additional capital and valuable connections and insight, but our model is not the same as a VC; both of us know this and depend on one another in various ways.
6. Variety of industries and models
“We use our 60+ years of combined experienced to invest solely in B2B SaaS platforms in the wearable fitness space… for pets” is not something we will ever say. For our model to work, we can’t limit the top of our funnel by eliminating whole industries and business models before we ever see them. While we do have a wide range of backgrounds (retail/ecommerce, agriculture, real estate, fintech and law), we don’t know everything. When our own expertise falls short, we rely on our trusted network to help us evaluate the technology and market, and we’ll use that information to help inform our analysis. Who knows, maybe we’ll have to call upon the firm that does focus on pet wearables to evaluate this interesting “Fitbit for hamsters” pitch I just got in my inbox…
7. Stay scrappy
It’s just me at the office and I know everything that goes on at M25 Group because I built it from scratch. We do hope to hire another person for the launch of Fund #2, but overall I would expect us to stay very lean. With this, we can decide on investments quickly and move on, staying efficient. By not having a lot of staff, we keep our fees low (and therefore not a drag on our returns) and our flexibility high.
It is hard to be this lean while also seeing hundreds of deals and managing current investments. We’ve accounted for that with some of our deal-sourcing methods and by only investing passively, but admittedly it will probably still be difficult. Nevertheless I’m confident it’ll work and we’ll continue to find ways to drive efficiencies. We are already enacting processes and policies to enable us to stay scrappy, which I believe is the best way for us to quickly adapt to the constantly changing macroeconomic environment.
8. Standardized analysis and strict fund plan
A lot of our fellow investors (typically angels) may not have much sophistication in their approach — which is absolutely fine if they’re not managing other people’s’ money. However, we analyze each opportunity with the same weighted metrics and we have a clear plan in place for our fund’s deployment [It’s a somewhat complicated model I plan on sharing in the future]. This forces me to be as objective as possible when making investment decisions, and prevents me from deviating from our carefully thought out plan because “I really like this one…”
So that’s a pretty decent summary of our strategy. Obviously we are still very new and these can still evolve, but I don’t expect the basic tenets to shift. Though, if you are still concerned about me only being 23, I completely understand — my birthday is in February so we can talk then.
