The Hidden Asset
During the past few months amid the COVID-19 pandemic, there have been radical shifts to the way business is done — forcing all companies, large and small, to evaluate their own version of an uncertain future. Within the venture capital industry, there have been no shortages of webinars and whitepapers attempting to shed light and provide insights as to how this may play out. The common theme around startup fundraising and investing opportunities remains a focal point within the industry — which is not a huge surprise. These are the areas that generate headlines. And with new funds raised, founders are able to continue to build their story.
Looking forward, I believe two things will remain true. First, companies will still need to raise money — and the most attractive companies will still have competitive terms and limited investor access. Second, and as shared by my colleague in “Why Managing Burn is So Important”, there will be a shift from a “growth at all cost” mentality to a “cost allocation” thought exercise. Taken together, founders have a choice when it comes to their investor syndicate, and there is an opportunity cost to choosing any partner — and as the general startup ecosystem emerges from these unprecedented times, I believe that choosing the right investing partners matters now more than ever.
To effectively do this, founders need to balance their fundraising decisions with the strategic goals of their company. That means reviewing all a fund has to offer. As shared above, there is a great deal of focus on the investing side of a fund. Though extremely important, the investing side does not capture the entirety of a venture fund’s value. Think about trying to judge how good a baseball team is by only watching players’ at-bats. There is an entirely different half of the game that strongly plays into whether the team wins or loses.
The point is not to try and calculate what side of the fund (or team) brings home the “W”, but rather highlight that there are other parts of the equation that will need to grow alongside investment activities to create a winning model. And one of the parts to highlight is the Limited Partners (“LP”). The LP base of a fund is a hidden asset, and if leveraged correctly, can play a critical role in driving value for a founder even in the most uncertain times.
So What is an LP?
I write this fully understanding that many of you will read right over this part. But that is also the issue I am attempting to escalate. All LPs are not created equal.
Let’s start from the top — at the most basic level, LPs provide the dollars in which venture capital funds use to invest in companies. And LPs come in various forms. For example, LPs can be individuals, endowments, fund-of-funds, corporations, etc. At a minimum, LPs expect to earn a financial return from the VC’s investing activities. And in certain cases, especially for corporations, LPs expect other value in the form of strategic returns. Strategic returns are not as black and white as financial returns. These unique returns include, but are not limited to access to thought leadership, investment opportunities, proprietary research, etc. Often it takes the coordination of the investment and LP management teams to successfully deliver on the strategic return of the value equation. A founder who understands what type of LPs his investors have can help signal if there are opportunities to drive more value from the VC — founder partnership.
And that brings us to the first point: VCs closely coordinating with strategic-focused LPs not only proves to be fruitful over the long-term relationship between the fund and LP, but also drives value back to a fund’s portfolio companies.
Getting to Know Your Investor’s LPs
Every founder knows how valuable it is to have feedback — both good and bad. The problem typically isn’t finding the feedback, it is finding credible feedback. As consumers, evaluators, and customers of new technology, LPs can share perspectives that often cannot be obtained through other avenues of information gathering, thus providing unique insight to a company and its leaders. This can be done formally through Proof of Concepts or more informally through discovery and reference calls.
Many LPs have vast operations and resources across the globe and areas of expertise that span decades of research, development, and innovation. For example, they can be an international conglomerate with hundreds of subsidiaries covering everything from consumer goods to healthcare. LPs can also be financially focused organizations (e.g. insurance companies) that are looking to diversify their holdings and keep abreast of the latest innovations in their field. These LPs are a resource and can help founders understand how a technology, service, or product is viewed and used in the market. This type of network and access to experts is invaluable for portfolio companies.
I know this tends to go against our default way of thinking that founders are the source of truth for how their product works and why it is better than other solutions in the market. But once that product is released into the wild, the control for how the product is used becomes somewhat more opaque— case in point, Frisbies were originally invented to be pie containers. Whether it is digging into industry trends or understanding specific use-cases, portfolio companies can tap into credible sources of truth that exist outside the walls of the company.
And the value doesn’t stop with just the founders, having this access will drive value throughout the entire organization, helping with product ideas, shortening sales cycles, building relationships at the right level, forming internal champions, understanding competitors, etc. The list goes on, but ultimately LPs can provide perspective to why you will win (or more importantly, why you will lose). Your investors have these connections— use them (your sales, product, and marketing teams will thank you later, trust me).
Really Getting to Know Your Investor’s LPs
Startups raise money for a variety of reasons and the underlying reasons are to support growth. And with growth, the fact is there will come a time when a founder will enter into areas that go beyond his/her comfort zone as well as the company’s core expertise.
LPs can be the partner that provides that soft landing for founders. Whether it be as a partner, customer, or simply as an advisor, LPs can help direct founders as they launch new product categories, tackle new industries, or enter into foreign geographies. This allows a startup to evaluate the resources needed to commit themselves to this new area of growth. And as part of a fund with LPs that are based out of the U.S., I have seen time and again how the right match between a portfolio company and LP can significantly reduce the time, money, and frustration that ultimately accompanies entering new markets.
In addition to the guidance LPs can provide, they also provide their seal of approval. Having a prominent logo in a new industry or a key partner in a foreign region not only fuels a CEO’s growth ambitions, but also builds a foundation of credibility that would often take much longer to achieve without a strong partner.
Building and Maintaining the Relationship
As part of the fundraising process, founders have already gone through the exercise of how they want to grow their team and business. Asking “is my investor syndicate optimized for helping me achieve these stated goals” is a simple litmus test. Of course all VCs can make introductions, help with hiring, and provide board advisory; however, each fund is different in its strengths in a variety of other factors. It is of great importance for founders to understand the specific value each of their investors brings to the table. Sometimes this decision will be based on industry expertise, sometimes it will be based on network, and sometimes it will be based on previous relationships. There are a variety of factors for founders to consider during the fundraising process, and the LP base is one element that can drive meaningful value to founders if correctly aligned with the vision of the company.
This philosophy goes beyond purely leveraging a fund’s LPs for one-off needs— it truly is having them on the team as a trusted advisor. So whether you explore building relationships with your investor’s LPs to have them as customers, distributors, co-investors, or advisors, the goal remains the same: create a network of stakeholders where collective interests are intertwined beyond a single transaction.
I’m Brent Wu, one of the Partners at Geodesic Capital. I’d love to hear from you and discuss anything software or Japan related. Please don’t hesitate to get in touch via LinkedIn.