“What did you change about Homebrew III to better fit ‘seed phases’ versus seed rounds?” a fellow VC asked me after my previous post. That’s a great question! One consistent LP complaint I hear about new’ish fund managers is that they forget a bunch of fund construction and portfolio modeling decisions are connected. The amount you raise, the average check size, your follow-on strategy, the fund staffing and so on — these aren’t single points but instead need to all be driven from one’s mission and strategy. For Homebrew, we’ve optimized for a product offering that will appeal to our target customers (founders) and maximize spending our time being hands-on supporting startups. So if you look at each of our funds as a version of a product release, what’s new or different about Version, errr Fund, 3.0?

Actually not much. We’re still working with a very small group of institutional LPs, making a target of 6-8 investments each year during the seed phase, and keeping the partnership tight. But there was one non-traditional request we had and which our LPs agreed to support. We lengthened the initial investment period as well as the fund itself. In simpler language, Satya and I anticipate making more total investments in this fund (~32) than we did in the previous two (20 and likely ~25 respective), while not fundraising again until ~2022 (versus a more typical cycle of raising every three years or so that many < $200m funds employ). To execute this strategy we decided that ~$90m was the right size for Fund III. Here’s our thinking behind these figures:

• Seed phases require patience and we don’t want companies to try and raise their Series A before they’re ready

When a VC is fundraising one of the stats they like to present to LPs is the quality and size of follow-on in the portfolio. For a seed investor like us that would mean “How many companies have raised a Series A (or later) and how good [brand name] are the investors leading those rounds?” This can sometimes consciously or unconsciously cause a VC to feel pressure to get their investments into their next round and marked-up in order to show momentum. In the first two Homebrew funds we’ve not always seen a correlation between speed of subsequent fundraising and long-term durability of company. Especially with founders who are in markets where they start earning revenue very early in a startup’s lifecycle, they sometimes choose to “fund” their business using this revenue and then go out when ready for a Series A. Creating a longer fund cycle for ourselves is consistent with the spirit with which we want to engage the founders we back and reduces the potential for mismatch between our incentives and theirs.

• Larger, longer fund gives us a better shot to hit our recycling goals

Ok, as if this entire discussion wasn’t inside baseball enough, if you don’t know what recycling is, first read Brad Feld’s post. Since recycling depends on cash flow a larger fund with a longer deployment increases the odds that we’ll get capital back from early exits that we can redeploy. We’ve generally got a recycling target of ~110% and minimally want to get to 100% invested.

• Time diversity is our friend

Simply put, we believe four years is better than three for achieving time diversity at the seed stage. Optimizing for spanning cycles of ups and downs, new ideas and models, etc. Being able to make enough investments to survive expected mortality rates and focus on durable outcomes.

• Time spent helping Homebrew investments is better than time spent fundraising for Homebrew

While we’ve been VERY fortunate to always have relatively straight-forward fundraising processes there’s no denying it does take some time that, if we’re being short-term greedy, we’d rather be spending with our portfolio and new founders.

Of course, while that’s what we’re optimizing for there are some secondary consequences of this strategy which ultimately impact Homebrew.

• More fees in the near term but harder to get to our target returns multiple given increased fund size

We’re long term greedy – for us the economic rewards of success come after our founders and LPs get paid, but that’s a feature not a bug. So the fact that a larger fund gives us more capital to spend on Homebrew operations upfront (which might include an increase to our salaries) is fine but it’s also essentially a loan we’re paying ourselves since we pay this money back to our LPs prior to sharing in the upside of the fund. And to get to a target return of 4-5x net, it means we need to return 5 * $90 million (ie $450m) to our investors. And if you assume ~10% ownership for Homebrew, well, you can do the math on exit value requirements.

• Need to remain disciplined with regards to check size and follow on decisions

If you raise it, you spend it. That’s what we tell to founders who take on a big round with the idea they’ll stay judicious in how they use the capital. Satya and I are pretty thoughtful about this stuff and since we make decisions by consensus, this one doesn’t worry me but we’ve noted it as something to keep an eye on.

• Fund IV will be raised off data, not momentum

Fundraising for VCs is always a bit of “remember how good we’ve been” plus “look how good we seem to be doing now” plus “here’s why we’ll well-positioned for the future.” There’s a certain cynical aspect of me which believes the fat middle of “just ok” VCs are in some perpetual game of fundraising when the above three attributes are just enough to get a fund done – ie timing the fundraise. By pushing Homebrew IV out a bit, I think we’re amplifying the idea we’ll be raising off results, not just momentum. Of course we think this’ll be to our advantage but… 🙂

• Our J Curve and early IRR may look worse than other funds

Another inside baseball issue (read about J Curves) but since our LPs are pros who care about cash on cash returns, understand our strategy and generally are seeing lengthening time to liquidity in venture, we aren’t too worried about this.

So, that’s basically what we’ve changed about Homebrew III compared to earlier funds in order to support our belief of Seed Phases. We document this stuff publicly because it helps collect feedback on our thinking and in the spirit of collaborating with other new fund managers.