Last week, Haystack hosted an event tailored for emerging fund managers featuring a panel of battle-tested and seasoned GPs. These individuals have many years of relationships with institutional LPs, deployed hundreds of millions of dollars of capital, and witnessed the many ups and downs of running a venture capital firm. As someone with limited experience in the world of fund management, I thought this was an informative and highly *tactical* event. I’m quickly sharing some of my key takeaways from the evening, which can shed some light on this otherwise murky world.
Nature of the Outlier Game: Each investor agreed they had never seen a fund return over 2.5/3X+ net without one investment that was 10X. This follows the conventional wisdom of venture, but the comments here validated that it happens in practice. One can’t aim for doubles and triples — there’s a lack of consistency across the distribution of returns. Startups are inherently unstable, and managers have to be risk-aware and comfortable with risk absorption.
The Evolution of Reserves: Most of the OG seed investors (Kopelman, Maples, Sacca, Conway, Clavier) were diversified without reserve capital as part of the strategy. This meant that these GPs couldn’t put more money to work in startups that were working, but founders also knew what exactly what their original deal entailed. They couldn’t go back to seed investors for follow-on funding because it was never part of the agreement. Now, many seed funds reserve follow-on capital, creating some ambiguous situations because they can’t follow on into every company first checks go into. From a manager’s perspective, the main question with reserves is: should I play offense or defense with reserves? Offense is proactively putting more money to work if you have a hunch something is working, and defense is typically bridging or giving a company more runway to figure out the right product + growth strategy. I’ve found these decisions are more art than science because there’s still very little data to go off of at the early stages.
Internal Consistency: This theme of the night was hammered home when one GP mentioned that “internal consistency” was the biggest thing Yale CIO David Swensen looks for when he’s evaluating talent. Has a manager done what she or he said they would do? It’s easy to waver on strategy with market ups and downs, but sticking to your word and original pitch seems to build credibility with LPs. This comes up quite a bit as managers think about pacing their investments and rate of deployment. Some know that they’ll raise new capital on two-year cycles and invest accordingly. Others don’t like the pressure of “putting money to work,” so their timeline is a bit more relaxed. I’ve also found this to be personally challenging, as I don’t have years of experience to measure time diversity off of.
Early Liquidity: One moment of debate hovered around what to do with early liquidity (early exits) in a fund. You have two options — distribute to investors (contributing to DPI) or recycle back into the fund. One might favor recycling because LPs want you to invest between 90-110% of committed capital, and you need to recycle money back into the fund due to the draw-outs from management fees. Recycling may be the right step, but on the other hand, LPs have a *real emotional* reaction to DPI, which should be leveraged. Distributing capital back to them early earns a form of trust and credibility, which will lay the foundation for the long haul.
Selling Secondaries: You can also get liquidity for your fund by selling secondary positions. Some managers have upfront rules that they pitch LPs with. For example, if a company is __x our cost basis with a valuation greater than __M, we’ll sell __% of our stake. It’s rare that the full position will be liquidated. One may miss upside potential by selling too early. There’s another complication too. While some like to claim there’s plenty of secondary liquidity in this frothy, late-stage private market, it’s not really the case for most companies. Often times, people want to buy your best positions, and you may not be inclined to sell i.e. “this company is valued at $1B, but it could easily IPO at $10B.”
These principles serve as a healthy reminder to me that it’s easy to get caught up in the day to day of making new investments and supporting companies, where new ideas and strategies are constantly being thrown out. However, there are investment management lessons (maybe some specific to venture), which have been pretty consistent over the years, and there’s no need to reinvent the wheel.