Humans deeply believe that people get what they deserve and deserve what they get, despite evidence to the contrary. So many of our cultural biases are stories created to justify realities we would like to perpetuate. For millennia we’ve been told that royalty was special, and that’s why they were in charge, when it was patently obvious that their ancestors were just the best and most ruthless at organizing enough troops to control a chunk of land. Genghis Khan was history’s greatest murderer, which enabled him to spawn kings and kingdoms that lasted for seven centuries, but you can bet his descendants didn’t use his skills at genocide as justification for their lofty positions.
In other words, there’s an implicit matching algorithm at work in VC, where companies that are obviously doing well are able to work with what look like the best firms, and as a result, they reinforce each other’s success. The best firms look better because the best companies seek them out, and the best companies do better because they’re getting the chance to work with the best brands. (For all that I am skeptical of repeatable investment skill, I am a deep believer in the value of brands.)
Managers that are forced to raise funds of <$20MM (or “Nano-funds”) shouldn’t assume that a few portfolio mark-ups will translate to a larger 2nd fund with institutional backers. Today, LP’s are discounting mark-ups and many managers that were anticipating a big step-up in size from their first fund are encountering challenges. It’s not difficult to understand why either — the liquidity cycle for seed funds is very long and demonstrating real traction in the typical 2–3 year period between funds is inherently tough. As such, new Nano-fund managers likely will have to raise multiple smaller funds before institutional LP’s pony up. To help mitigate this a bit, GP’s should constantly be in fundraising mode, even between fundraising cycles and in truth, many LP’s require that they know GP’s for years before allocating.