Brief Thoughts On VC Fund Management
If you’re a new or relatively-new VC, you simply must download or stream this new 20 Minute VC interview of Michael Dearing of Harrison Metal (download here). Harry Stebbings does a great job with this one. There are two key reasons to spend the time to listen to this — One, Michael is obviously known to be one of the Valley’s pure outstanding investors, and two, as he rarely opines so publicly, the wisdom he shares toward the end of this podcast with respect to fund management is gold. While a new investor can raise capital, build a network, and pick companies with somewhat relative ease, the art of managing a fund, portfolio, and multiple funds and companies across rounds and markets is very difficult to just pick up. Instead, fund management takes time, requires making mistakes, needs mentorship and guidance, and so forth. For me personally, it is both a topic I’m obsessed about and also struggle to learn. There isn’t much of a shortcut in that process, but I think this short podcast actually provides a little sliver of a shortcut.
There is lots of other great stuff in the interview, I won’t summarize it all here because you should hear it. The topics which stood out to me as they relate to fund management are:
1/ Price Sensitivity: There’s been a lot of talk in the angel & pre-seed space that effectively price shouldn’t matter if you think an opportunity will be huge. Yet, so early, it’s very hard to know, and in today’s environment with angels, syndicates, new LP types, and more, it’s significantly easier to raise a seed round in the Bay Area. Dearing has a different spin on this — calling pricing the way a manager manage their risk. In his view, price is just one consideration, which should always be managed against the investor’s conviction in a business, demonstrated progress, and/or management team.
2/ Recycling: Many LPs will say they prefer their managers to recycle funds (see Brad Feld’s blog for more on this, particularly on recycling management fees) as a way to help the LP put all of their dollars to work. In theory, it makes sense, but in practice, the manager needs a relatively quick exit to make it work. With that liquidity, the manager then elects to reinvest that capital. Dearing has a different operating principle, citing that he would rather get the liquid funds back in the hands of LPs quickly versus taking ownership over the decision on how to deploy the funds.
3/ Today’s Bay Area Seed Market: Most market observers know that, at least in the Bay Area, it’s beyond crowded. Dearing’s point of view here helps frame the divide. He essentially says the seed market has bifurcated: There’s a wing of the party which consists of professional managers with professional LPs who are mostly all pricing deals reasonably and careful around risk vs reward… and, there is the convertible debt wing of the party which is basically “undisciplined” with a “tulip auction vibe” and “toxic.” It is hard to argue with either Dearing’s expertise and this description.
4/ Reserve Allocations: This is a big topic of debate when VCs raise funds from LPs. I will write on this topic more later this year. Essentially, managers want to reserve some amount of capital against each investment they make for a variety of options, although those dollars aren’t always allocated equally. To do a proper reserve model, it requires many disparate assumptions about the overall market, the market for acquisitions versus downstream VC funding, and whether there are better uses for each dollar in question. Like most parts of fund management, what is often done in spreadsheets turns out to be more art than science when played out in real life.