So you want to be a seed investor?

Some thoughts and opinions on micro VC investment management and strategy

Although I haven’t raised a venture fund myself, I’ve spent a good amount of time learning from and speaking with a handful of technology investors at the earliest stages, most recently as an intern at Notation. The micro or small-cap venture capital phenomenon is fascinating, as dozens of funds managing under $150M have sprung up the past five years to focus on the earliest stages of startup financing.

As I’ve spent more and more time in this ecosystem, I do believe these funds are quite difficult to run, especially if you haven’t developed a strong strategy acclimated to the investment environment you’re dealing with. Here are the distinct viable strategies I see for micro VCs.

Strategy A: Aim for Diversification

If you aim to ‘diversify’ your seed portfolio and invest small amounts of capital into many companies, here are the general mechanics of how it could work:

• Your typical check size ranges from $25K-$200K. It’s probably better to hone in on a single number that you use most of the time, but aren’t married to it 100% of the time.
• You invest in about 25–50 companies per year depending on deal flow volume, market conditions, and fund size.
• You must come to terms with the fact that you probably won’t be a super hands-on investor. You have limited bandwidth and a large portfolio. Most value add will manifest itself as companies pulling you in for specific requests over outbound pushes.
• You can be less sensitive to ownership and price because you are theoretically putting money into a lot more companies. Additionally, there’s a low probability that you’re setting terms for the round. This venture fund model from Sam Gerstenzang is a good starting place to think about the mechanics of how this would work.
• Most of your pro-rata activity will come through SPVs in later-stage rounds as opposed to coming out of your core fund. You will also get more favorable economics this way.

Strategy B: Buckle Down on Ownership and Price

If you believe you can be strategically helpful to your portfolio around specific functions like product, operations, hiring, customer acquisition — you might want to consider an approach focused on investing larger amounts into fewer companies.

• Your typical check sizes range from $400K — $1M. Again, try to hone in on an average check size — $500K is probably a good place to start.
• You will probably invest in 6–15 companies per year and really buckle down with each of them for the next 12–18 months (when they’ve raised their Series A).
• Find the few functions that you’re most helpful with for your portfolio. In terms of what’s generally useful, having a deep bench of prospective hires and future venture investors in your rolodex can go a long way.
• You must be disciplined on ownership and price. Negotiate accordingly and don’t get carried away with the noise in the ecosystem. There’s also a strong chance you may take a board seat or set the terms for the financing. The model from above can help you think through this.
• Allocate a reasonable chunk of your committed capital for pro-rata. Ownership is the name of the game, and pro-rata reserves will help you fight dilution down the stack.

Strategy C: The Hybrid Model

This is probably what I would do if I were starting a venture fund tomorrow.

• Write checks of $100K — $250K for 90% of my portfolio and checks of $500K — $750K in 1–2 incubated projects per year.
• Invest in 15–20 companies per year. For most of the investments, I would try to get into “hotter” deals in order to build rapport with a strong SV network and be less concerned about ownership and price. It’s also trickier to negotiate on price and terms with a great entrepreneur if you run a newer fund.
• Buckle down with awesome founders on 1–2 incubated companies per year to build meaningful ownership stakes in areas I find exciting.

Investment Management Recommendations

Apart from higher-level fund strategy, here are some tactical suggestions and recommendations I have for operating and managing a micro VC.

Investment Memos

Good investors should consistently write thoughtful investment memos tailored and designed for their limited partners. These memos allow for clear communication with limited partners and provide a time stamp and proof of record for an investment decision. Here is a good post I read from Tim Devane on them.

Great Lawyer(s)

This is often overlooked but a very important part of your investment practice. Good lawyers can catch unfavorable terms, help prevent dilution, and appropriately transfer ownership and pro rata during future financings, especially if you’re playing with convertible notes and SAFEs.

Portfolio Cadence

Depending on your strategy, set a cadence for catching up and staying on top of each portfolio company. Try to set up a weekly / bi-weekly / monthly / quarterly call with the founders to maintain a rhythm for communication. It is important to keep in mind that you should only do this if the founders are willing.

Corp Dev and Growth Investors

Build relationships with strategic partners and corporate development folks, as well as growth-stage investors. Figure out who the good people are and constantly circulate with them. After all, these are the firms and funds that will mark you up or cash you out.

Secondary Investors

Get to know individuals and firms that will buy secondary shares in technology companies. There may be instances when you need to cash out some of your investment for liquidity purposes, and it’s always good to have some people you can go to in these instances.

Accounting and Tax Structure

Brush up on your accounting and have an understanding for best practices for tax-efficient structures and vehicles. This stuff gets outsourced, but that doesn’t mean you should ignore it.

Transparency

Be upfront, honest, and transparent about what you will and won’t do for a prospective investment. For example, founders pitching First Round understand that they’re getting a productized solution while founders pitching Benchmark know that they will be lucky enough to work with someone like Bill Gurley.

Handoff Packages

This is a place where I think you can go above and beyond for your portfolio. If you have a list of service providers or templates of operating models / KPI trackers specific to their type of business that you can hand off to an entrepreneur, I’ve seen this go a long way.

Ideas and Deal Flow

One way you could build deal flow is by publishing and writing about the types of ideas / frameworks / models you want to see in the world. Ultimately, I believe the best founders will always show investors the Promised Land rather than the other way around, but I do think this is a good way to get interesting conversations going. On a personal basis, with my Requests for Startups, I’ve met a handful of interesting and curious technologists and product folks looking to start their next thing.

If you found this compelling or have your own ideas on early stage fund management and strategy, I would love to hear from you. My email is aashaysanghvi[at]gmail.com.