I’m Optimistic: Extending my Thesis to Kanata’s Strategy — Part 2.1

Chris Kay

Published in

Kanata Ventures

9 min readJul 18, 2024

This post is part of a series. You can find my previous posts here:

The major themes in my previous post were about:

Operating in early-stage markets where large VC firms have less of an edge over small VC firms;
Taking advantage of whitespace opening up in the early-stage market as a result of the bifurcation of the VC industry, and
Even further focusing on pre-seed where we believe there is the best risk adjusted return.

In this post, I’ll show how these themes are being reflected in Kanata’s Fund Strategy.

Key Functions of a VC Firm

I think it’s important to first level-set the key functions of a VC firm (or almost any buy-side investment firm). There are many variations on this concept (here, here, here, and here), but here is my take:

I’ll breakdown each of these six key functions, and describe a few selected principles we use when executing our strategy.

1: Be Prepared

The introverted analyst part of my personality gets the most excited at this stage in the investment process. Being prepared can take many forms, but here is a non-exhaustive list:

Proactively doing research and becoming familiar with market dynamics
Identifying emerging trends, macro tailwinds, non-obvious big markets, gaps in markets, areas of opportunity, markets susceptible to or experiencing dislocation
Identifying characteristics or advantages that founders and startups would need to possess to be successful in a particular market or business model.
Developing an understanding of why now? What has changed? What was missing then? What exists now that could make it work? What is required to dominate a market? Who are the incumbents?

I think being prepared is an under-appreciated stage in the VC investment process. For example, it’s not referenced once in any of the “Key VC Firm Functions” variations I mentioned earlier (here, here, here, and here). In my opinion, being prepared is foundational to the other downstream stages. It can inform sourcing and assist with honing sourcing efforts. Being prepared front-loads the effort which speeds up building conviction, and enables the deepening of conviction needed for non-consensus or contrarian bets.

“Chance favors the prepared mind”
- Louis Pasteur

To dig deeper into this topic, I highly recommend the Acquired Podcast episode “The Sequoia Capital Playbook”. I also think Alpaca VC’s Field Study Program is a great research methodology.

Specialist vs Generalist: Leveraging our Domain Expertise & Industry Contacts

Investing is hard. Venture investing is hard. Early-stage venture investing is harder. It’s even harder to be prepared, gain a unique insight into an emerging market, build conviction in a new venture, and be non-consensus and right while being a generalist.

“It’s not supposed to be easy. Anyone who finds it easy is stupid”
- Charlie Munger

Kanata is definitively focused on investing in startups selling to B2B Enterprise, with a tilt to a few key industries (I will expand upon how and why B2B Enterprise in my next post). This focus plays to our strengths as managers as it allows us to leverage our prior industry domain expertise and industry relationships. For example, my other company, Multiplicity specializes in consulting to corporate innovation teams in multinational enterprises.

“Non-consensus specialists can be really good at spotting ideas and teams that can defy the odds. Knowing how industries work can help them overcome the non-consensus nature of certain investments.”
- Frank Rotman, QED Investors

Proactively Develop a Point of View on Markets

Having a specialization and being prepared culminates with developing a point of view on a market, business model, or investment opportunity. Ali Hamed, Co-Founder and Partner at CoVenture described this really well on the Invest Like the Best Podcast:

“If you look at the venture capital business model, there’s two types of seed funds. There’s the seed funds that listen to their Series A friends, hear what their Series A friends want to see, and then go find companies that they think their Series A friends are going to go back. And those seed funds should be called originators.
There’s other seed funds or early-stage funds that develop a point of view to the world of what they think should exist. They then invest in those companies and try to convince downstream funders that they were right. That’s the Union Square Ventures model.
They have oriented their entire business around having a megaphone that they can tell people ‘we invest in this company because we think it’s a good idea. Now our job is to convince you it’s a good idea’. That business has a much higher profit margin than the sourcing and origination business that a lot of early-stage funds have come into.”

2: Meet Great Founders

The entrepreneur and technologist part of my personality gets the most excited at this stage of the investment process. It’s truly energizing to meet smart entrepreneurs who have their own view of the world and have dedicated themselves to attempting to shape the world to their point of view.

“The reasonable man adapts himself to the world: the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.”
― George Bernard Shaw

Early to Markets: Finding Markets that Are Small Now, but Will Matter in the Future

A common theme running through my previous post and this one is finding and playing in markets that possess a high “Opportunity-to-Competition ratio”. For example, ideally finding markets with a high risk-adjusted return, and low levels of competition. Being prepared is the setup to finding markets that are small now, but will matter in the future. Markets that are perceived to be small now should have limited competition from other VCs. If those markets grow to be significantly meaningful in the future, the opportunity side of the ratio should be satisfied as well.

“Non-consensus deals don’t always come from the typical channels so non-consensus investors have the ability to generate deal flow that other investors aren’t interested in”
- Frank Rotman, QED Investors
“We generally like the more non-obvious markets where they’re good tailwinds, the markets could be small at the beginning, and it can grow over time.”
- Alfred Lin, Partner at Sequoia
“TAM Arbitrage it’s the idea that if you can do the work and understand the market better than anyone else, and appreciate that it’s actually bigger than anybody else gives it credit for, that can help you pay higher prices.”
- Kyle Harrison on 20 Minute VC

3: Build Conviction

The idea of being non-consensus and right as the fundamental method for generating above average returns or profit started with Howard Marks, but has been referenced by Andy Rachleff, then Mike Maples, Jr.. Being a rational actor and making a non-consensus bet requires conviction, especially to stay the course to find out if you’re right or not. Doing the work (due diligence) to build conviction allows us (the Kanata team) to be a little more contrarian and “pull the trigger” without social proof from other investors.

4. Come to an Agreement

First-cheque Specialists: We Get to “Yes” When Others Say “No”

This idea should be credited to Frank Rotman of QED Investors, in his May 2022 white paper “The Three-Body Problem”:

“Non-consensus alpha VCs are typically first-check specialists. There are overlooked teams, overlooked geographies and ideas that require a leap of faith, many of which are never taken seriously or never seen by most VC firms.”

High % Ownership Relative to Size of Fund

According to Michael Kim, founder of Cendana Capital, the seed-stage industry standard for target percentage ownership in portfolio companies is 15% for a $100M fund (and 7.5% for a $50M fund, etc). Apparently, there is a linear relationship between the size of a fund and percentage ownership in each portfolio company shown in the graph below.

This is another dimension of venture investing that can level the playing field between large established VC firms and small or emerging manager VC firms. This relationship has also been noted by Rob Go, Co-Founder of Nextview and Alex Edelson, Founder of Slipstream Investors.

5. Support

Provide Founders the Most Value Per Dollar Invested & Per Equity Allocation

Earlier I mentioned that high percentage ownership relative to fund size is a dimension of venture investing that can level the playing field between large established VC firms and small or emerging manager VC firms.

Investor % Ownership = Cheque Size / Post-Money Valuation.

By definition, small funds are constrained by the size of cheques they can write. To secure a high percentage of ownership relative to fund size, small funds also need to be reasonably diligent about valuations. Additionally, the investor percentage of ownership is exactly equal to founder dilution, unfortunately it’s a zero-sum relationship (pre-money and post-money deals somewhat change this dynamic). The only variables to alleviate these constraints are the brand of the firm, the reputations of the Partners, and the perceived value the VC is bringing to the table beyond capital.

Crossing the Chasm from Contrarian to Consensus Bets

As a small emerging manager, one of our greatest risks is that downstream investors don’t see the potential we see in our portfolio companies, and they fail to secure future investment. This could happen for a variety of reasons: we were wrong about the founder, market or product; we were too contrarian; we were too early, or the company is not perceived to be attractive enough relative to their peers also seeking capital, etc.

Aside from just being right, I think we have three options to mitigate this critical risk:

Invest in startups with the ability to reach a cash flow positive state, and reduce the immediate need for further outside capital.
Deliberately add value and de-risk portfolio companies, making them more attractive to downstream investors relative to their peers also seeking capital.
Maintain frequent two-way communication with downstream investors to identify risks early, and advocate for our portfolio companies.

6. Exit

Please Note: I plan to cover this section in greater detail in my next post on how and why B2B Enterprise. Additionally, Kanata is too early in our journey to be diligently focused on exits. However, as Dwight D. Eisenhower said “plans are useless, but planning is indispensable”.

Due to the fact that we are emerging managers and our portfolio construction (small fund size and target percentage of ownership), we need to optimize for increasing the probability of outcomes, not necessarily the magnitude of those outcomes to achieve a respectable fund return.

According to Sapphire Ventures, between 1995 and 2016, venture-backed enterprise tech companies have generated $825B in exit value over 4,600 exits, versus consumer tech with $582B in exit value over 2,600 exits. This means enterprise tech has generated a larger aggregate exit value and a higher volume of exit transactions compared to consumer tech.
(Source: Part 1 and Part 2).

Looking at the universe of exit opportunities from a different perspective, the Q1 2024 PitchBook-NVCA Venture Monitor Report showed +1,350, $100M to $500M exit transactions in the 10-year period between 2014 to Q1 2024 in the United States.