Why Creating An Innovative VC Fund Is Also Entrepreneurship
I am a VC. I have not been paid for 14 months. I invested my savings in our project. When I come back home every evening, I take my doubts, fears and hopes with me. Everyday, I’m working with a great team of 8 people with whom we started from scratch, reinventing (according to us) the way our job must be done for next ten years (at least!).
And yet, I don’t allow myself to call me ENTREPRENEUR. You asked me why? Because I am … a VC. That is to say, in a lot of minds, the exact opposite of what is being legitimately considered as entrepreneurship.
I easily understand why it’s hard for entrepreneurs to see VCs as people of their own. I identify 3 main reasons.
1. VCs don’t build the biggest company possible (yet?)
When an entrepreneur invests time, talent and money in his project, it’s done with the ambition to make the biggest business possible at the highest valuation.
And even if there is, in almost every case, a deep proximity between the entrepreneur and his company, entrepreneurs are growing an organization, that is to say a structure with a technology, a brand and employees whom mission is to maximise growth.
On their side, VCs are also founding a company, yet their job is not to make the biggest one. Their job is to maximize the ROI of the fund (their investment vehicle) they manage. This is how they get their remuneration, in the form of carried interest. The company itself, called management company (the brand name that public knows, eg USV), is not meant to grow and develop as startups do. On the contrary, the management company must be totally long-term oriented and safe, in order to guarantee the sustainability of the different funds it holds. And VCs work under the authority of regulators and financial supervisors (as the French Financing Authority, called AMF), so they have to commit a serious part of their own financial assets but can’t take significative risks on the management company’s PNL. It’s important to say a word about the PNL for VCs. To understand it’s specificity, imagine that your PNL (at least the profit part) is designed to remain the same during the first 5 years of your company. So each significant hire or expense (all the more the recurrent ones) must be questioned, because you can’t forecast a revenue growth. Weird, isn’t it?
2.The VC model is a mix of management fees and carried interest
We saw that management companies are not designed to grow exponentially, investing money and taking risks like entrepreneurs do. Management companies’ reason to be is to carry investment vehicles. But the difference with startups also lies in the rigidity of VCs business models.
VCs’ budgets have nothing to do with startups’ ones, as VCs have nothing to sell.
Indeed, management companies are taking an annual management fee on the amount of money they raised from their own investors (the Limited Partners). It approximately represents 2% of the fund, each year. This is true during the first years of the fund (normally around 5 years). Then VCs are getting a percentage of the amount of money they have invested in startups. This is why VCs try to raise new funds every five years: it compensates the drastic loss of revenue entailed by the model.
However it’s far from the up and downs that entrepreneurs can live with their PNL. Yet, even if of course VCs are also driven by the performance of their investments, under the form of carried interest that they share with their LPs, this general scheme of management fees makes entrepreneurs say that being a VC is a riskless job. And regarding the poor average performance of the industry, it’s not totally false to say that some VCs are only “living on the fee stream”.
In a word, entrepreneurs get rich thanks to the performance of their company while VCs are rewarded thanks to the performance of their funds and not because they sell the shares that they hold of the management company (which value is often low compared to the money it drives).
3.VCs are not entrepreneur friendly: they say no 99.8% of the time and often harshly
VCs spend their days saying no to entrepreneurs. Not because they don’t like them: it’s a question of maths. Let’s take our own example. We anticipate to receive an average of 2,500 applications each year. During the investment period, it means 5*2,500 = 12,500 pitches. We will invest in around 25 deals. This represents a NO-ratio of 99,8%. This is unfortunately inherent in the VC game.
So this is not hard to understand why most entrepreneurs don’t consider VCs with a lot of empathy and see them more like bankers than entrepreneurs. And there is no denying that the behavior of some VCs reinforces this feeling. At daphni we experienced it during our own fundraising process. As entrepreneurs, we were really stressed and gave a great deal of importance to the behavior of our discussion partners, trying to interpret their signs and using post-rationalization reflexes.
I love the way Eli Portnoy puts it in his article My first VC Meeting — A Tale Of Brutal Rejection. It should remind us to treat entrepreneurs with the highest respect and empathy.
“I vividly remember my first VC meeting like it was yesterday, even though it happened over 10 years ago. I was awed and intimidated to meet an industry insider, someone who with a single decision could transform my business prospects. I prepared for weeks, polishing my deck, practicing my talking points, and rehearsing answers. I couldn’t sleep the night before I was so nervous, anxious, and excited. […] I expected the meeting to start on time, but the partner was 20 minutes late. He was cordial and nice, but clearly wasn’t nearly as excited to see me as I was to see him. The meeting started and I began my perfectly rehearsed presentation. I hadn’t finished the first sentence when the VC interrupted me with an idea. I hadn’t even said what I was working on, yet he already knew how to improve my business. He pontificated for a full five minutes and then let me continue with my presentation.”
Launching a VC fund IS entrepreneurship
And yet when it comes to my own situation, I am not afraid to say that I am an entrepreneur. Let me explain why.
First, to be sure that we talk about the same thing, let’s quickly define what entrepreneurship is, thanks to Peter Drucker.
“This defines entrepreneur and entrepreneurship — the entrepreneur always searches for change, responds to it, and exploits it as an opportunity.”
This search for change implies putting studies, career and financial perspectives into risk, for the sake of the project. According to Professor Howard Stevenson, the godfather of entrepreneurship studies at HBS, “entrepreneurship is the pursuit of opportunity beyond resources controlled.”
Agree with that? Ok, let’s see now if our project can fit this definition — daphni is its name- .
Let’s consider the degree of entrepreneurship of daphni
When you ask investors to say what is the most important element in an entrepreneurial project, “TEAM!” has become the canonical answer. This is what we first did at daphni: bringing together a tight team of passionate co-founders able to start a new page of their professional and personal life, with a fair amount of risk and craziness. As of today, 3 other great talents joined us, attracted by the non-traditional way we take our job.
Having conducted dozens of interviews with entrepreneurs plus having analyzed that crowd-structured and digitalized investment vehicles were platformizationing the old VC model, we decided to:
- create our own digital investment platform
- create and manage our own innovation community (daphnipolis)
- create and develop a lifestyle-like VC brand
On paper, it seems to be quite easy. In reality, it means:
- Changing ourselves in product guys (it didn’t work), then recruiting a head of product and two developers and significantly lowering our compensations to give room to these new talents on the payroll.
- Motivating more than 150 entrepreneurs, executives, academics, designers, … to join and invest time and money in our adventure. We will grow and manage this community, abandoning the tranquility of VC blackboxes for transparency.
- Breaking the codes of the classic brands of the financial world with a strong and friendly identity, taking the risk to be considered as not serious and legitimate enough.
This 3 points could be unfolded in 3 autonomous articles. But this is not the point, I think you got my point. I would just add that my cofounders, who each hold 15 years of experience in the VC game are also investing a very significative part of their savings in this new experience. For them, daphni and its success or failure will have a significant influence on their assets, reputation and career, in a positive or negative way. They could have made the choice of comfortably staying in their respective funds.
I’m entrepreneur and it’s just fine
Yes creating an innovative VC fund is also entrepreneurship so I feel like I am an entrepreneur. And this is good news:
I know what it means to strive
We have to raise funds and it is NOT easier to raise a VC fund, as our investors are not gentler than VCs to startups. It’s a priceless lesson: when you repeat your pitch a hundred times to bored investors, you develop a huge sense of empathy with entrepreneurs who have to face the same kind of wall. It helps to create a more horizontal relation with them. This is something very precious and useful that I am proud of.
Questions, doubts and further questions
Everyday the question of the future of daphni is at stake. Will it survive competition and digitalization of our world? Is the value proposition clear and attractive enough to convince the best entrepreneurs to work with us? How can we improve our processes, platform, decision making and support of our portfolio. This is a sample of the questions that keep us awaken at night. But we do it with the conviction that being entrepreneurs help us to be way better VCs.
Yet I know that venture capital is a very specific job that leads VCs to say NO 99% of the time to other true entrepreneurs who are playing with their professional life. And in that, I have a great responsibility of respect and professionalism.
Now time will help us to prove that we are good entrepreneurs, which is a different kettle of fish.