The Finer Details Between Investing and Being an Investment Manger
Hunter Walk posted earlier this week and alluded to a constellation of activities a venture capitalist engages in beyond meeting with, investing in, and managing a portfolio of startups. His post grapples with the challenges operators face when they transition to VC, as they are typically excited about working with and investing in entrepreneurs but are less aware of the investment management and sales duties that are critical to successfully operating a venture capital firm.
Hunter described how his operator friends typically cite intellectual stimulation, helping entrepreneurs, and the diversity of projects as the reasons they want to get into venture capital. These are valid, and I would not discourage anyone from pursuing VC if they are motivated by these activities. It’s true that learning about new technologies and talking with startups every week is incredibly intellectually stimulating. Going through the investment process of due diligence, advocating for a deal, and ultimately closing is exhilarating. And yes, working with companies after the investment is hands down the best part of the job. But mastering these skills alone is not enough to make a great venture investor.
Since breaking into the VC industry a little over 4 years ago, it’s been a non-stop education about everything from what makes a good investment through to how to manage capital calls (more on that below). What I have come to learn is that to truly be great at this business means immersing yourself in all elements of running a fund, not just the glamorous stuff. I think this is the biggest surprise not just for operators breaking into venture capital but also angel investors transitioning from investing their own money to managing institutional capital.
I thought I would expand upon Hunter’s original post and share some of the finer points I have learned over the few short years on being an “investment manager and salesperson.”
Portfolio Modeling & Construction
There is so much more to this than simply what stage do you invest in, what size of check do you write, and how much do you reserve for follow on. Its understanding exactly how your fund size ripples through the rest of your strategy. Its understanding what’s happening at a macro level and as round sizes get bigger how that alters your model. Its understanding what ownership levels you need to achieve in order to return meaningful capital relative to your fund size. Its understanding what the appropriate cadence of investment should be and when you expect to be back in market. Its understanding where you are in your fund’s lifecycle and how that impacts decisions. Its understanding when to recycle capital rather than distributing some of it back to your LPs. Its understanding how the number of companies you invest in compared to the number of partners on your team impacts the amount of involvement you realistically can have with each company. Essentially, there is a difference between just investing in a number of companies and hoping it all works out versus optimizing for returning capital at a fund level.
If you didn’t like raising money as an operator, you won’t like raising money as a VC. The “I just want to close this round so I can get back to building a business” becomes “I just want to close this fund, so I can get back to investing in founders and working with our portfolio.” And unless you are part of a name brand firm, raising a fund usually takes much longer than raising a round for a startup. It’s fairly common for a fund to take 12–18 months to raise. And many institutions will want to see some track record of prior funds before they invest which means you likely will be building relationships with some potential LPs for 5+ years before they consider actually investing in your fund. Please don’t take this as a complaint because it’s not. It’s a privilege to be in this position but the reality is raising money isn’t fun no matter if you are an entrepreneur or a VC.
I’ve come to realize that while its relatively straight forward to model out capital calls, its more art than science on when and how much you actually call. Why? Because while you want to ensure you have the necessary capital to support the deals you want to do, you don’t want too much excess capital simply sitting in your bank account. Not only is it a waste for your LPs, who could be putting that capital to better use, it’s a drag on your performance relative to your IRR. You also want to smooth out the amount of capital you call as to not inconvenience your LPs. Nothing like pissing off your investor because you are asking them to wire far more money than they were expecting.
You know how I mentioned I wanted to get involved in all aspects of the business, including the not so fun stuff? Welcome to the not so fun stuff. Even though it’s a pain it has to get done and in a timely manner, so you can provide proper reporting for your LPs. This is where organization and ensuring you collect all the necessary docs and info at the time of investment really saves you a ton of time and headache on the backend. Nothing is worse than having to chase down some doc 6 months later. If you lead deals and are a major investor it’s much easier because you have information rights. However, if you are an investor that doesn’t lead, figuring out how you will obtain info on the company is difficult but critical. Being efficient at data collection isn’t likely going to make or break you as an investor, but it is part of managing a portfolio and being a good fiduciary of your LP’s capital.
Proactive Communication with your LPs
Just as investors expect their portfolio companies to provide them with regular updates, LPs expect the same thing from their GPs. Are Fred Wilson and Bill Gurley amazing investors because they communicate with their LPs? Probably not, but it’s definitely part of the job and easy to forget about when you have a million things going on. But this goes beyond simply providing your LPs with an update on the portfolio every quarter. I think the good ones can open up dialogues with their LPs and actually leverage the insights they have. The institutional LPs often times have tons of experience and have a vantage point that could be very beneficial for a GP.
Building a Reputation Over Time
Venture is a unique industry in that you compete against the same firms and individuals as you collaborate with. Founders and other investors will remember how you acted during negotiations and as companies go through times. You want to ensure you are always playing the long game so that founders tell other entrepreneurs they should work with you, earlier stage investors want to send you their best deals, and later stage investors want to invest in subsequent rounds. It’s not necessarily about being “founder friendly,” it’s about being there when things get challenging, keeping the company’s best interest at heart, and doing all the basics well (showing up on time, being prepared, remaining attentive and engaged, following up in a timely manner, etc…). One of my favorite lines about this that I have heard from multiple VCs goes something to the effect of “your returns are driven by a few winners; your reputation is driven by how you handle the rest.”
These are some of aspects that go into being a VC that many aren’t aware of or don’t fully comprehend when entering this industry. I’m sure there are more. It’s hard to really understand a lot of these elements without having worked through them in real life. I think that’s why VC is still ultimately still an apprenticeship business. Even if a successful VC didn’t previously come from a VC fund, I bet just about all of them had mentors (ie: VCs at other funds) that taught them a lot of this stuff.