What I Tell All New VCs About Their First Funds

No Need To “Grab a Coffee and Pick My Brain” Because Here’s What I’d Say…

A lot of new venture funds out there these days. People sometimes ask me, “wow, is there still room for new investors?” and my answer is that generally while a particular zip code or two might feel ‘overfunded’ at a moment in time, that early stage entrepreneurism is still UNDERFUNDED globally by at least an order of magnitude. So yes, there is definitely room for new investors, especially if you are going to execute at least one of the two following competitive advantages: 

  1. Fund people/ideas ahead of consensus — that is, find founders and markets that aren’t currently being chased by the mainstream and get to conviction ahead of the pack.
  2. Be more helpful than the folks on cap tables today who overpromise and underdeliver — every cap table I’m on has some percentage of allocation that provided zero value after the investment. If you can be more valuable than that, I’d love to bring you on to the cap table of the next seed round we lead.

So besides those points, here are three things I generally advise folks raising their first funds…

A. It’s Not Always Worth Doing Second and Third Closes: I generally believe new investors underestimate the challenge of fundraising and investing at the same time. We had the incredible privilege to raise our first fund quickly and get focused on putting it to work, but the history of new managers not hitting their hard cap and just deciding to show proof instead is longer than you’d think. There are a handful of notable and quite successful folks who back in the day just closed what they could and got to work. Once they had momentum they raised a next fund 12–18 months later (vs the ‘normal 24–36 month cycle). If you’re targeting, let’s say, a $20m fund and can close on $10–12m but are really struggling to fill the rest, just don’t worry about it. Close the fund and get to work. You can invest relatively less per deal or go back to market sooner with evidence of your momentum in hand.

B. Take Some Risks, Even If They Deviate From Your Deck: Sometimes I see new VCs get over-concerned about deviating from the strategy they told their LPs they’d be executing. I’m a believer in 80/20 models here (unless for some reason your strategy was really wrong and you need to pivot more dramatically). If you do 100% of exactly what your deck said you’d do, I’m suspicious that you’re not being aggressive enough on responding to changes/opportunities in the market. If you do 0% of what was in your deck, well, then you don’t really have a strategy. But early on our LPs reminded us that they were outsourcing their judgment to us and fundamentally trusted the decisions we’d be making. This gave us the license to stretch every now and then towards an opportunity which didn’t exactly fit our model but was a calculated risk.

C. Focus On Quality Of Pick, Not Absolute Ownership, But Try To Stay Within Your ‘Weight Class’ As Often As Possible: Ok this is really inside baseball but it’s important to set up your second and third funds, which are often raised on perceived quality of Fund 1, since it’s before actual results are delivered.

Generally assuming most first funds are preseed/seed, I think of them as writing checks within a particular ‘weight class’

Supporting Checks of $50k-$250k for <5% ownership

Supporting Checks of $250k-$750k for 3–10% ownership

Lead/Co-Lead Checks of $750k+ for 8+% ownership

These are obviously all estimates and ranges but you can think of a basic cap table as a pyramid where there might be a lead or co-leads, then a bunch of supporting checks of various sizes. As a new fund you’re pitching LPs that you’ll be investing in a certain number of companies over the lifetime of the fund, usually with a check size range and/or initial ownership target. You also might be holding some reserves for follow-on in future rounds for your most promising investments.

I’m going to make that case that in your first fund what you’re trying to prove is that you have good picking and access within your weight class. You are not trying to prove that you can always hit the high end of your ownership target, at least not to the detriment of quality of pick. You are also not necessarily trying to show that you can manage a great reserve strategy, although doing so successfully can help your returns, and as your funds grow larger, you’ll need to develop this skill.

Why am I saying it’s better to get in at the low end of your weight class target than pass great opportunities by? Because (a) great companies dramatically outperform good ones and (b) LPs will believe that more capital (ie a larger Fund 2) will help you get more allocation within your weight class and deploy follow-on dollars. They won’t believe that more capital will make you a better picker! That is, the argument that because your fund was small and you held to hitting certain ownership targets you were limited to average companies is a losing strategy. Now it’s still quite important to stay within your weight class or at the top of the one below yours. LPs will generally believe that if you got $250k into companies on average in Fund 1 (and the companies were solid and your references are positive) that you’ll be able to get $350k, $450k, etc into companies if your fund was a bit larger. Or use those additional dollars to hold your ownership in one or two successive pro rata rounds. They will raise an eyebrow if you are trying to move from a Fund 1 of $50k checks to a Fund 2 of $2m ones. It’s just a different slot on the cap table, a different fund operations model and a different competitive set.

There’s a lot of nuance still in the interplay between check size, ownership and portfolio management. There’s also the aspect of sometimes needing to hold your ground on your ask. If you develop a reputation for always taking the least offered to you, well, even a nice guy like me will push you down in rounds so I can get mine.

I’m always open to helping new managers and my contact info is available on www.homebrew.co. Also, I’m part of an effort called Screendoor which helps back emerging managers from underrepresented populations. The future of VC shouldn’t look just like me. If you’re raising a fund feel free to check out Screendoor and see if we’re a fit for you. Good luck!