Q&A: Principal at Early-Stage VC Fund

I work @ a $500M+ VC/Venture Growth Fund and have gotten some phenomenal feedback from this forum over the past few weeks.

With all this scary COVID stuff wanted to try and be positive and pay it forward. I also saw a great recent thread here about our asset class being a shit-show and thought there might be interest in something like this :)

My background prior to venture was in product management and I've been in this job for close to 4 years. Led several Series A-C deals and sit on a few boards.

Questions on "How to Break into Venture generally or for my specific situation" are better answered over DM.

Ask away!

 
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While in PE, I noticed people take a "lawyer's" approach to building investment theses - start from the ground up and use data to build your case, and use inconsistent data to modify as needed.

However, in VC, I have noticed at my own firm and others' that there is a strong thesis bias, where diligence consists of finding ways to confirm the deal originator's thesis, either through limiting market research to current customer calls, searching for favorable market trends, etc.

I am not trying to discount the intelligence or analytical rigor of VCs, and I think that one of the key reasons this happens is because of the lack of data and lack of budget for diligence. E.g., a retention cohort analysis means a lot less for a pre-hockeystick Series B company with a customer footprint exclusively in the valle than it does for a mature, national company.

What are the specific tactics you take to building a strong investment thesis? Whether they be techniques or useful mental models, please share this with the community, because this is something that has been woefully absent from most VC discussions thus far.

In my own mind, VC is "sourcing", "picking", and "growing", and I hope you can help elucidate the second of the three.

 

Yeah I agree with your assesment - most people do take a "lawyer's" approach if they are thematic.

I think great thematic investors excel at assessing:

a) Market Timing: why is the adoption curve for this technology going to accelerate now versus down the line. Take AR/VR as an example - I think most of these technologies will eventually take off, but investors have lost a ton of money here because they were too early.

b) Evolution of Category Economics: how will the broader technology and space evolve in 3-10 years, all factors considered? Good example of this that comes to mind is the Bill Gurley vs. Aswath Damodaran debate on Uber's market size/valuation. The latter argued that Uber's market size was limited because the rideshare market was the size of the overall taxi cab market. Gurley argued that network effects and downward cost pressure would make this market 30-50x bigger and was proven resoundingly correct. He could assess how the economics/incentives broader space would evolve given many different factors.

Many investors who are good "pickers" in Enterprise Software, or software generally, are ex-operators or seasoned veterans who have incredible instincts for both. That said, many rely on a few components

a) Expert/KOL Feedback: If you're looking at a company like Hashicorp at the Seed/Series A - you will go ask other folks in your network at AWS, MSFT, etc. for feedback on the idea/company. b) Longitudinal Survey Data: you either are looking at market trends from survey data ('I see adoption aerial imagery for XYZ use cases accelerating in ABC segments') or from conversations with your aformentioned KOLs. You're talking with customers, industry participants regularly and seeing how their priorities change c) Mastery Venture Mental Models: As you alluded to, there's particular investment frameworks that apply more in venture - things like network effects, systems thinking, Carlota Perez' work on tech. adoption, etc. Those are a few, impossible to list all of them and quite varied on if you're enterprise vs consumer

It's frankly a cottage industry that relies a lot on luck and seeing the best deals. You get better at picking deals if you have access/see the evolution of the best deals. VERY few investors are truly great pickers in the mold of Peter Fenton (Benchmark Partner, knows Open Source Software and can pick consistently better than anyone else).

It's less true intellectual rigor than pattern matching. Obviously intellect has a role but I'm speaking relative to other asset classes.

 

I am going to be working at a well known growth-stage fund (General Atlantic, Insight, TA, Summit, etc) and would appreciate your opinion on being a VC/growth investment analyst as a first job out of college. In the long run I see myself hopefully ending up in either VC or a F500 corporate role. My investment analyst role would consist almost entirely of sourcing, so despite my interest in tech startups and VC, I am concerned that I will not develop many useful/transferrable skills (not saying sourcing isn't useful, just feel that it might be necessary to develop other skills in relation to finance/operations as well). So, even though the role might help me get my foot in the VC door initially, I feel that it might not actually develop my abilities in a ways that are useful in corporate roles or even VC at a higher level (because startups like investors with entrepreneurial/financial/operational experiences). I am wondering whether you think consulting might be a better first job to help me gain some foundational skills that better position me to succeed in either VC or F500 in the future?

 

Those are all phenomenal shops that will give you wide latitude to pursue a career in growth equity, early stage venture, or operationally at a startup.

Do consulting if you want to work in more mature organizations/F500.

Re: Sourcing as a skillset - I think sourcing well is actually really hard and definitely a transferable skillset to operations, partnerships, and sales/strategy roles at many companies. You develop a scrappy get it done attitude that serves you throughout your career. Your exit opportunities from consulting will be wider, certainly, but GA/BVP/IVP on your resume early in your career can be as valuable as some brand name MBAs later in your career.

If you're too early in your career to know -simply ask yourself if you deal with ambiguity in professional situations? Do you like it when your boss gives you no directions but asks you to go find XYZ answer and execute? Then you will love venture and startups.

Do you want more structure in your day to day/direction? Then later-stage investment firms or consulting are the better answer. Hope that helps.

 

Mistakes are varied but things I see: - failure to be self-aware on shortcomings vs. strengths as company grows. It is really hard esp. if you've been ambitious/a go-getter your whole career - obsession over strategy versus balancing intellect/insight with speed of execution - not growing as a leader into someone who can serve the leadership team OR not finding a core area of functional leadership as the company grows - hiring "B or B+" talent at positions because you don't know what A level talent looks like. - raising too much at crazy valuations - not TRULY diligencing investors (going for shiny logos or friendly folks versus doing thorough background checks on investors)

Underexplored areas: Hard to pinpoint, but if I had a single one... cloud + enterprise software in Asia is just beginning and will be a generational investment opportunity. I own a fair bit of Ali/Tencent/Baidu stock. The opportunity for cloud in Asia (China in particular) is massive and just getting started. I find it hard to believe AWS/MSFT will own the same market share there as they do elsewhere for a variety of reasons.

 

You'll be able to pick up the cold-emailing, learning, soft-skills, etc. if you're half-intelligent. Learn QUALITY over QUANTITY and how to make your direct superior look like a rockstar.

5 great calls and leads a week >>>> 25 half an hour mediocre calls. Everyone confuses activity for skill their first year.

  • Go to someone more senior and ask him to share 10 of the last best companies he/she has looked at. Study the notes, the team composition, metrics etc and begin to pattern match.

  • Only elevate or advocate for opportunities you. are THRILLED about.

  • The best deals are very competitive by nature. Learn to present action plans with how you think you can get time and win. the CEO (founder intros, stalking at a conference, customer intros, advisor intros).

Every year I stay on this job I triage better between "good opportunities," "solid opportunities," and "great opportunities." If you're doing things right you're surfacing 5-10 solid opportunities a yea and maybe 1-2 great opportunities.

Become someone who consistently elevates/advocates for solid opportunities versus getting excited about everything. Become someone who presents next steps and makes a principal/partners job easier. Send notes on market/talk tracks to your partners to make them look good on their calls with the founders.

(Caveat: If you work at a shop where leads are assigned to analysts/managed like business development reps this might apply less so don't listen to me in that case)

Edit: Good tactic - in elevating deals you are excited about, also always highlight open questions you have. It makes you seem much more matured, measured in your analysis. And when you eventually do have true conviction and pound the table for a deal - people will listen.

 

Market/LPs want 3x Net Moic - that is ideal.

Venture LPs care about IRR, but that is super sensitive to timing which doesn't make too much sense in venture. Think about it - if you're a 5x fund. you have a great looking IRR anyways, and the scale of that just depends on when you exited XYZ $2B+ company in year 9 or 10 or 11 which is largely out of your control anyways.

So, when the ink is dried 15 years later most astute venture LPs will look at MOIC (and DPI along the way to protect against extension risk).

They don't actually expect higher! Counterintuitive, I know. It's because most of the asset class does so poorly. If you're 2x net MOIC you're essentially close to top quartile and getting another fund.

Why? Because venture is slugging percentage (how big were your wins) vs. batting average (how often did you get to 2-4x returns).

If you're consistently proving you have access to solid deals by having a unicorn or ~2-3 $250-$500 exits with high ownership - then you're showing you can be trusted to at the very worst return the fund and at the very best have a crazy multi-bagger. So LPs look at you as diversification/potential for a 5-8x net fund at the best and a 1.5x net moic fund at the very worst. They'll take that risk curve/profile all day - if they wanted consistent 2-3x returns they'd invest in growth equity or PE.

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