Yesterday, Nicholas Chirls and Alex Lines at Notation Capital launched the first episode of Origins, a new podcast about limited partners (LPs). As a sponsor of the series, I’m very excited for them. Their podcast aims to highlight the all-too-often missing perspective of LPs in venture — something that we at Sapphire are equally passionate about and is precisely why we launched OpenLP earlier this year.
But I’m also excited on a broader level because this podcast series gives me an opportunity to discuss why Sapphire is an LP in Notation, which, by our own definition, is out of the ordinary when it comes to our fund investing strategy.
The rules we (generally) play by
To explain why we pursued an “out of scope” investment, let me first explain our sweet spot as an LP. Like GPs, LPs have specific types of venture funds they target and check sizes they like to invest. These vary from LP to LP depending on their particular portfolio.
At Sapphire, our proverbial “sweet spot” for investment is in early-stage funds ranging in size from $125 million to $400 million (aka “disciplined” in size) with thoughtful portfolio construction and a clear point of differentiation. Loosely speaking we like to be 10 percent of a fund up to about a $20 million check.
We typically write checks in the $10–20 million range as we believe that amount makes us a friendly, meaningfully-sized investor for our GPs, but not overbearing, and can produce a meaningful return impact to our portfolio. If we write checks that are much smaller than that amount, those checks will have to work too hard to return our capital. And if we write checks that are too large and things don’t go well we could be in danger of underperforming our own return expectations.
But rules are made to be broken
Now that I’ve outlined our rules, to hell with them. We can, and do, invest opportunistically above and below these fund sizes.
And Notation is one time we did. Notation is a sub-S10 million fund, and our check into it is accordingly small. The parallel would be if a large venture fund wrote a small seed check. For the money to make an impact on the fund, it would have to do 10x or better. Pretty high bar.
So why’d we do it?
Notation is based in New York, specifically Brooklyn. This matters because prior to investing in Notation I had been looking to invest in New York City for a number of years, mapping the ecosystem while figuring out what to do from an investment standpoint. NYC has been near and dear to me for a long while. I lived there back in 2000, when I first entered the fascinating world of venture capital, working at one of NYC’s early VCs/incubators.
Ever since, I’ve kept a close eye on the ecosystem and watched closely as it’s evolved, trying to understand the types of companies that have thrived there and the stage and types of investments being done by locally-based funds (seed and A predominately) versus non-NYC based funds (typically later series). So I’ve invested meaningful time meeting with NYC-based managers and entrepreneurs. And over time, I observed a number of lighthouse New York companies create a wave of second- and even third-generation entrepreneurs. These are the signs of an ecosystem growing up and maturing.
I was, therefore, a soft and informed target when I met a brand new team on the brink of launching Notation. In fact, I met Nick and Alex while they were still in the ideation phase for their fund. They knew they were too small for a Sapphire check, so when they approached me it was about getting advice instead of money. We met occasionally to discuss their ideas and investment thesis, and as they started fundraising, I couldn’t kick the feeling that if Sapphire wasn’t part of their fund, we’d be missing something.
The case for Notation Capital
Notation Capital is a first-time fund, started by two second-generation investors/entrepreneurs with deep networks. Nick brought seed-stage investing experience from Betaworks, and Alex was the chief architect at Betaworks, ie. the “technical founder type”.
Through months of diligence, we found Nick and Alex to be incredibly well networked and well liked, and we really enjoyed getting to know them personally. What I especially liked about Notation at the outset is that I believe the fund has both a differentiated theme (to filter incoming deal flow) and a differentiated pre-seed offering (to attract entrepreneurs). There was also an arguable under capitalization in the NYC pre-seed area in which they were looking to invest.
Nick and Alex would be the first to say that Notation Capital is an experiment. It’s a fresh way of working with early-stage founders in NYC. It’s also an experiment that we believe offers Sapphire potential upside and small downside, given the relatively small check as a measure of the capital we manage.
We back emerging VC managers with the hope that we can partner with them for years, and possibly decades, as they build their firms. But it’s possible that Nick and Alex could run Notation Fund I and move on to something else. Not every VC manager, even if s/he is really talented, will want to be a VC for the rest of his or her life, and we understand that.
But Nick and Alex are off to a great start, and we believe Notation Capital has the opportunity to build a fantastic firm and brand in NYC. Of course, if their experiment works, they may well choose to raise a larger fund next time around, and that might enable us to put more money to work. The returns are appreciated along the way too.
So that’s that. We broke our own rules, and there are multiple factors that came into play to facilitate this.
I knew the geography and investing landscape well prior to meeting Nick and Alex and was predisposed to making an investment there. While small funds are by no means a guarantee of large returns, they have been known to “hit above their weight class” because one good hit can produce impressive returns. Case in point, Lowercase Capital’s sub-$10 million fund, which might be the best-returning venture fund ever.
Notation is targeting an arguably still under-capitalized section of the NYC market with a lot of head room above them. NYC might lack in local growth funds, but it does not lack for seed funds and has local Series A funds as well. Last but not least, Notation has a differentiated strategy — their deal flow is predicated on the next generation of NYC entrepreneurs looking to work with a technically-strong fund.
I’m personally very excited to see where Notation will go in the coming years. I, as well as everyone at Sapphire, am delighted to be along for the ride. It’s hard for me to call myself a true rebel, but breaking the rules does feel pretty good. After all, history was never made by those who follow all the rules.
Sapphire Ventures is a limited partner in Notation Capital.
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