When I first transitioned from the corporate sector to venture nearly five years ago, it was every startup’s dream to be funded by a top tier venture firm – targets such as Sequoia, Andreessen Horowitz, and Accel were all too common. Throughout the years, I’ve seen the power shift from top tier funds thanks to founders eager for more touch time (aka lean manufacturing).
The more time I spend in the trenches – on the investing side as well as on the fundraising side – the more bitter [sweet] is the realization that micro VC fund managers, particularly those “emerging” with their first or second funds, are underestimated and overlooked.
In the last 5 years, we’ve heard a lot of buzz about access to capital for diverse founders, but we are just at the knee of the j-curve in uncovering the value offered by small, and, underrepresented fund managers. The focus of this thought piece is precisely on funds managed by diverse managers and why they can be a better option for some early stage founders than top tier funds.
The idea of going small is prevalent and cherished in many business sectors. Think about intimate class sizes at a niche preschool or a hole in the wall restaurant with capacity in the single digits. Further, small colleges can make the post high school transition easier and offer more opportunities for natural and structured collision amongst groups with affinities than large institutions can.
Small business Saturday advertises a double bottom line approach to shopping that allows you to buy what you need while also promoting economic prosperity for small business owners. And increasingly, artists are choosing smaller labels or the Indie route to align values and incentives when releasing music.
In the venture capital space, we erroneously believe that power lies solely in the hands of investors who are either in or out ala Shark Tank. But really, the founders with an affinity to do things on their terms can find the investors who roll up their sleeves and focus on outbound reach: a mutual fit that extends fund returns, gross multiples, and brand recognition.
Here are five reasons why you, a startup founder, should overwhelmingly pick a micro VC:
1. Investors are committed & empathetic during your fundraising journey because they’ve been there.
In the last five years, nearly 100 new micro VCs enter the landscape and as of 2019, First Republic Bank tallied about 1,000 firms actively investing out of US-based home offices. It takes a micro VC an average of 18 months to close on a fund; competition for LP dollars for emerging fund managers is tough and so you know you’ll be comparing bruises and scars with your investor team. This kind of camaraderie is only found in places like first timer hot yoga classes, new mom groups, or the military.
2. A Micro VC team will be more likely to push all their partnership interests almost equally.
To be sustainable, micro VCs have to deliver performance that beats the [Cambridge Associates] benchmarks, so they are motivated to make you successful. In order to move from proof of concept fund to a sizable investment vehicle, micro VCs have to show they can access and win deals, and that the companies they invest in do well. The partners will be guided by a desire to be helpful and you’ll have the benefit of challenging their networks to accelerate time.
3. There’s a new wave of venture capitalists coming and your equity can lead to sustainable impact.
Venture capital and private equity have long been an engine of wealth creation for the owners of these management firms. Women and people of color have historically received microscopic allocations of capital at the startup and firm level even though studies have shown that diverse led funds (NAIC 2017 study showed that on an IRR and MOIC basis, diverse PE funds outperformed 62.5% of the time). According to a Knight Foundation study (see graphic below), only 4% of AUM in venture are women-owned, ~4% are minority owned, and ~1% are Latino owned.
You know the on ramps to wealth building in the private markets are full of obstacles and you want your success to matter. You want your cap table to be full of fund managers grossly underrepresented in VC.
4. Launching your initial board is critical, it needs to consist of people who exhibit human qualities >> representing big fund interests.
Your first cabinet should be full of talented people who genuinely care about your success and will surround you with others from their network who share their value set. You don’t want a board member who sees your potential and wants to come in and change you too quickly; you want the board member who loves you — flaws and all — yet finds the right opportunities to course correct you for mutual success. In an emerging micro VC, the partners are building their own board service track record and so they’re worried about your reference checks as much as you’re worried about theirs; adding value is imperative and top of mind for them.
5. Building a capital efficient business is critical; a micro VC helps you prioritize.
Micro VCs can build capital efficient early stage companies by filling the expertise gap, shepherding them to the A round and getting companies back on the traditional VC rails with certain standard operating procedures and altered DNA. This gap is where the value is created and risk can be removed in the right hands. Many larger and more institutionalized VCs are also screening for capital efficient companies.
For example, Boris Wertz of Version One Ventures wrote: “As an investor, nothing is more impressive than meeting an entrepreneur that has built a great business in a short amount of time and with very little money.” Pangaea Ventures, a clean tech VC, believes that the true innovators in their field are building capital efficient companies.
I know I said five things, but here’s a bonus:
While others may move on quickly, micro VCs will slow down enough to figure it out.
Emerging micro VCs investing at the early stage need to be alpha firms comfortable with coming in at the riskiest stage. They like to be among the first checks into a company and are often first. They observe how early stage startups struggle with proving to the world that they belong and can often help those founders in a unique way. Sometimes, they’re simply moved to be a part of an incredible founding team.
Where should you go to find these folks? First identify the right cross section of affinities for your team and start exploring. Good initial sources include the Kauffman Fellows program, BLCK VC, Latinx VC, Female Founders Fund, Gaingels, Portfolia, Backstage Capital, Harlem Capital and Chingona Ventures.
P.S. For the purposes of this article, a micro VC is defined as a venture capital fund with less than $100M in assets under management (AUM). An “emerging” fund or fund manager represents a first or second time fund manager leading a micro VC but not having spun out of a previous venture firm.