So you want to start a VC firm?
Earlier this year, a few venture Limited Partners and I were comparing notes around the dramatic spike in seed VC (or Micro-VC as they often are referred to) firms we observed in 2014 and 2015. Below is a table illustrating the growth of the sub-sector. .
The general consensus within the group was that the Micro-VC market was saturated and an expectation that we would start seeing definitive signs of consolidation of active Micro-VC firms at some point during 2016.
As of today, that prognostication hasn’t exactly materialized. Today, nearly 340 Micro-VC firms exist in the US, with another 300+ currently in the market for their first funds (using Prequin data). Anecdotally speaking, I met 1–2 new fund managers nearly every week this year.
The natural question that often (and appropriately) gets asked is whether this all is a good thing for the market or not. Like nearly anything in life, there are definitive pros and cons.
- The number of firms and accompanying surplus seed capital inevitably creates valuation bloat at the seed stage, thus impacting indexed Micro-VC returns. For the record, I think this is overstated a bit as the seed stage valuation market is fairly efficient today, and in actuality, only a small % of Micro-VC firms are currently set up to lead/price rounds.
- The low barriers of entry allow for touristy type of investors, who may not have the experience or skills to responsibly guide entrepreneurs through critical early decisions nor be can act as a good fiduciary for their Limited Partners. As history has shown, being a great entrepreneur or angel investor does not automatically equate to being a great institutional investor.
- For Limited Partners, choosing where to allocate capital is similar to throwing darts blindfolded as the vast majority of managers feel and look the same.
- Significant “smart” institutional capital for early stage entrepreneurs, something that became scarce when traditional VC’s went up-stream.
- The acceleration of diversity that Micro-VC creates (lower barriers of entry are not always bad)
- Niche focused managers that serve as real experts in extremely nuanced industries and sectors.
- Help in fostering innovation to hubs outside of the major tech centers. This is true both within and outside the US.
- Returns for the top performing Micro-VC’s significantly outpacing returns from top traditional funds (albeit with a different risk profile).
With all that being said, we continue to firmly believe the Micro-VC boom to be a significant net-positive to the industry, regardless of how crowded or touristy it may feel now.
While I don’t dispute the detracting comments, the pros far outweigh the cons by the mile in mind (I will however note that with regard to the common complaint of stunted index returns due to saturation, I think it’s a meaningless point as it’s nearly an immutable fact that VC is an outlier driven asset category, and the best managers will do amazingly well for their investors and entrepreneurs regardless of competition.
Given that backdrop, I want to impress on the importance of aspiring venture fund managers spending the appropriate amount of diligence and self assessments prior to launching a venture franchise. I realize the romanticism and appeal of becoming a VC — after all, getting to invest in and work with smart and talented entrepreneurs that may change the world while making a great living sure does seem compelling.
However, it must be reiterated that managing a venture firm is much, much more than just investing in cool companies and having an elevated profile in the market.
In truth, the bulk of time managing a venture firm is not investing. Rather, time is spent on things like fundraising (can be long and painful), constantly making mundane firm infrastructure decisions, being a great partner for your Limited Partners, managing firm culture and brand, taking countless meetings you don’t want to take, and having to wait many years to figure out whether your efforts have been successful or not.
And rarely are personal economics for Micro-VC managers that great until almost a decade in (if ever).. In fact, a manager of a $25MM seed fund is probably economically in the red until a second fund is raised, when opportunity cost and general partner buy-in to the fund are factored in.
While starting a venture franchise today is an achievable task, managing a venture firm is an incredibly steep and challenging undertaking, and should only be pursued by individuals that are willing to commit to the long game. As I’ve said before, a true passion for every element of building a venture firm is necessary.
For those that are ready to make the long term plunge, it can be an incredibly rewarding path, particularly when passion and firm success intersect.
In my next post, I’ll be discussing the primary components of Micro-VC differentiation.