Yesterday, I attended my fourth Cendana Micro VC Summit in San Francisco. As I’ve done in years past, I wanted to briefly summarize how I perceived the mood of both LPs (the money source) and GPs (those who allocate to founders) in today’s current environment. [For a look back on my notes from previous years, click on either 2014 or 2016.]
Briefly, and in no particular order, here’s what I thought about in finding patterns from the panels and chatter:
1/ LPs seem more resigned to the fact that exits will take longer, perhaps never materialize. Think about that. After years of being on stage asking for quicker exists, the data has come in and unless someone holds an LP position in a fund with an outlier exit, these are simply really hard to come by and manufacture right now. It will be interesting to see what this implies for the LP side. I suspect for many, after some reflection, the model may not work. That may not be a bad thing for the ecosystem, however, but could cause pain for those looking to keep raising institutional funds. We could expect some consolidation, too. (I’ll write separately on how the exit environment could affect micro VC behaviors in another post.)
2/ Seed is entirely its own asset class. I have felt this for years and finally yesterday it became clear to me. The return profile, the way to pick, the types of people — it’s not really micro VC, it feels entirely different.
3/ A cottage industry is forming around helping new fund managers build out franchise firms. Building on Point #2 above, we now see a range of service providers for fund formation, legal counsel, accounting and financing, back-office operations, diversity & inclusion consulting, and executive coaching for smaller funds who aspire to build into franchise firms.
4/ Traditional VC firms weren’t a topic of discussion. Building off of Point #2 above, seed really is its own asset class. I didn’t hear much talk about the bigger established funds at yesterday’s event. Usually, people like to name drop or cite funds as aspirational targets or funds they’d love to see their deals go to for reputational signal, but I heard none of that yesterday. Perhaps that’s because the gap between seed and the Big VCs is getting even bigger to the point where it isn’t on folks’ radar.
5/ No one can outrun the math. Earlier this week, I linked to an excellent interview Michael Dearing did with Harry Stebbings on The 20 Minute VC. In that chat, Dearing provided a great frame for the seed market, which he believes has “bifurcated” into two camps — the camp that relies on convertible notes and is not price sensitive may not have enough ownership in their winning companies to return principal capital back to their LPs. Moreover, I personally believe we will see a lot of good funds with great/smart managers have portfolio vintages from 2013-2015 that may not see even one company realization & exit above $100M in transaction value. That wouldn’t be a big deal if most micro VC funds were around $10M, but many of them are quite big in size. We can all keep running, but we can’t outrun the math.
I want to thank Michael and Graham from Cendana and Jim, Alex, and the entire SVB team for always putting on the event, for inviting me, and asking me to moderate a great panel. Each year at this I’m reminded of the fact that Michael and SVB were so early to see this category emerge, which now boasts nearly 570 “new managers,” defined as having fewer than three institutional funds under $150M. There are 163 firms with new managers raising $5.4B (with 58% of these raising under $30M; and 14% of new managers are female), dominated by the Bay Area with NYC and LA following. A quarter of new managers are spinouts from established VC funds, another quarter are serial founders, while the rest are mostly operational executives — most don’t have legit return data yet. (Source: SVB, Cendana)
The panel I moderated was with very experienced institutional seed fund managers (MHS, Homebrew, SoftTech, Forerunner) on how they progressed from institutional Fund I to Fund II. The key takeaways were for me from that panel are (1) the relationship-building between GPs and LPs should be thought of in years before a business relationship consummates; (2) sharing bad news and the ‘warts’ upfront helps build trust and also helps filter for LPs and GPs who they can trust to enter into business with; (3) stick to the strategy that you told LPs you’d execute on, as too many funds “veer” off strategy; and (4) as funds grow, the GP’s time and mindshare needs to be protected and scaled by investing in key fund operations.