Brand-name growth funds may dominate the headlines, but an industry secret is that the best return profiles in venture capital have historically been produced by newcomers and in the early stages of investing. Data from Cambridge Associates shows that new and developing firms are consistently among the top 10 performers in the asset class accounted for 72% of the top returning firms Between 2004-2016.
The early stage is where you’ll find the most budding managers, based on the fact that <$150m funds investing in pre-seed and seed companies are often earlier in their lifecycle. Funds are rising first: Most are < $25M and are supported by individuals and families willing to take the risk on a manager with a short track record. It's a smart bet, because the first three funds are when a manager has the most to prove and is doing the hardest. They run a different calculus than later-stage funds: They're optimizing for big returns, not management fees, to build their reputation.
They are probably starting their own fund because they see an opportunity they think others are missing – which is what venture capital is all about.
Despite outperforming established funds, emerging funds are still under-invested. Shows data from NVCA and Pitchbook That in the past fifteen years less than 40% of enterprise allocations have gone to emerging managers. For endowments, emerging funds may not be able to meet their size requirements, but for new funds of family offices and fund strategies, this opens up a huge opportunity: Better returns and Easy Reach (through innovative manager selection, low minimum commitments, and fundraising that stays open longer than brand-name funds).
We are starting to see more and more LP strategies to seize this opportunity, which certainly proves the return potential. Even more established firms that have traditionally invested in “blue chip” funds have now mobilized dedicated vehicles for this vintage of seed managers.
high return profile
For career venture managers who are strategic about portfolio building, the path to external returns is, generally, to gain meaningful ownership in future unicorns at the lowest possible entry point. The challenge is, how do you predict the winners?
For the LPs that support these managers, the question is how to gain exposure to as many winners as possible. According to a recent report by Verdis Investment Management, the seed asset class is power law driven, meaning that there are a small number of outliers (1-2%) that give almost all returns. Volume is a key part of their strategy: by having a strategic network and exposure to 1,000+ seed investments across geographies, they can increase their chances of catching a unicorn in their portfolio. Since investing directly in enough startups for this strategy to work is challenging, it means investing in multiple seed-stage managers who have portfolios of 50+ companies.
Jamie Rode of Verdis Investment Management explains, “We decided to have our own seed fund of funds in 2017, which had 20 seed funds, and now has more than 1,000 unique companies and 23 entry points with Series A and below entry points. Getting in touch with Unicorn. That portfolio. The results exceeded our expectations and we have now increased the synergy of the funds we commit.”
This strategy has added benefits when the public markets are experiencing volatility. While seed investing is risky (seed-stage startups have Estimated 2.5% Chance To become a unicorn), the pre-seed and seed rounds are untouched by the turbulence of the later stage because evaluation entry-points are generally still attractive.
Jamie shared data They ran through a regression that confirms what we early stage investors recognize on a daily basis – Since you are investing for an exit environment 8-10 years in the future, there is no correlation between current public market conditions and early stage enterprise returns.
While the dynamics of the power law of seed investing mean that volume can be a hedge, the “spray and pray” strategy of getting exposure to as many deals as possible is rightly criticized. Finding the best managers who are going to be able to replicate success and consistently reach the best deals is paramount.
evaluation of managers
As I’ve written before, many budding managers are at one point grappling with whether to start their own firm or join an established one as a partner.
Once they make the leap, budding managers have the promise of high returns but short track records. So how do you rate a great one?
Many of the best-performing funds in the VC asset class are the smallest, early-stage funds, and many of them are run by emerging managers,” according to Alex Adelson, founder and general partner of Slipstream, in early-stage funds. a limited partner.
Alex says he looks for managers “whose investment strategy is consistent with their unique, sustainable competitive advantage, who have shown they add significant value to founders, and with whom founders and other investors love to work.” ” It is also important for them to understand the right ownership goals for meaningful returns.
While there is no one-size-fits-all background that spells success for a budding manager, he finds former operators who can provide strong domain expertise to founders who have the edge.
Winter Mead, who runs Coolwater Capital, the studio and accelerator for launch and scaling emerging investment managers, agrees. They have seen VCs from a wide variety of backgrounds, “including finance, marketing and PR, each provide key skills and strategic advice that have helped founders and companies scale and reach the next level.”
Jamie takes the opposite position. She shared that “most of the 38 seed funds we’ve invested in so far and that fit our general model are not ex-operators. This is usually because their portfolio creation aligns with the power law thesis.” Doesn’t happen, we believe in too many shots on target. Most ex-op VCs believe in a focused portfolio and board seats where they can help build the next outliers. She wants her GPs to focus do picking outliers, no Make them — and certainly not trying to salvage companies that aren’t viable.
“It doesn’t matter if you’re not into a winner, how bossy you are,” she says.
Reaching startups early is not just about favorable entry-points, but being ahead of the market on big trends, emerging sectors and new profiles of entrepreneurs. Jamie notes that emerging managers can provide “differentiated and diverse access to a pool of startups that more established brand names may not have access to.”
non-consensual alpha That comes from exploring opportunities that are overlooked – often in underserved geographic areas and populations. Most of these opportunities are preferred by budding managers, because even though established funds see these deals, they may not be comfortable taking the risk.
Coolwater sees inbound applications from more than 1,000 aspiring managers each year, and works closely with a selection of these teams through its Build Program. Winter shared, “Over the past year we have worked closely with over 60 curated emerging managers. Sixty percent are from non-traditional VC cities (outside SF, LA, NYC and Boston) and more than a third are international. Aspiring VC founders are finding new opportunities to spot talent and build innovation ecosystems in places that have historically been hard to reach.”
For LPs investing in seed, backing a group of similar managers who have exposure to similar deals is not a sufficiently diversified strategy to win. It is far more beneficial to create an index of managers who are making non-agreed bets with minimal overlap.
That being said, there are a few trends that relate to better returns: According to Jamie, geography (most winners come from California and New York) and network (the value of a network in a startup) can reduce the chances of success.
During recession, tie up with builders
If the great financial crisis of 2008 can be viewed as a proxy for our current recession, we can expect funding to slow down in the later stages, but new company formation and seed funding will continue unabated.
In fact, one of the most striking trends of the 2008 crisis was that New companies were created and financed at an increasing rate – and revolutions in fintech and the sharing economy were born out of it.
A pullback like the one we’re experiencing now could actually have a positive effect for seed investors: Founders who want the money are forced to grow responsibly and focus on business fundamentals, such as their the path to profitability. Less publicity will make it easier to separate winners from those who ultimately won’t survive. It may be counter-intuitive, but the best times to build and invest are often when we’re feeling the pinch the most.
Credit: www.forbes.com /