What is an Emerging VC Manager's Edge?
Despite tweets like the above, it seems as though we are entering the Golden Age of Venture Capital.
Driven by the enactment of policies like Regulation Crowdfunding and the development of products like Rolling Funds, many more operators and founders have entered the proverbial arena; taking advantage of the tectonic dislocation of geographic location and quality startup dealflow. Venture capital is both growing and unbundling simultaneously.
That said, this important work is far from complete. To usher in a future that is more normally distributed, we must increase the aperture of not only those who have access to funding, but also the men and women actually doing that funding. That is, the myriad of talented individuals eager to dip their toe into the traditionally-frigid waters of early-stage venture capital.
Put simply, it starts with diversifying not only founders but also funders.
A promising subset of these funders are emerging managers; those men and women whose assets under management (AUM) range from $10 – $50M and who have typically raised less than three funds. These types of managers play a vital role in the “growing and unbundling” of the VC landscape given their focus on previously-overlooked founders and markets.
One such person backing these intrepid managers is Ben Ehrlich. Chief of Staff at LTSE and General Partner of First Momentum Capital, Ben believes that emerging managers have different characteristics from established players and can be viewed as a distinct, high-performing asset class.
He may well be onto something. The data shows that smaller funds run by emerging GPs tend to outperform.
That said, capital is a commodity.
How do you pick the best GP or investor for the long haul? Investing is a lot like a marriage—wonderful when it works and ugly when it doesn’t.
Given First Momentum’s mission of creating the next generation of great venture investors by backing managers raising their first institutional fund, we turned to Ben to learn how he assesses the next generation of talented capital allocatoooooors.
Over to Ben!
When looking at new funds, the first thing I try to identify is: does the manager have an “edge.” Essentially, what is unique about the manager and how he/she will deliver impact and returns.
I use a basic framework to help me understand the manager’s edge:
- Does the manager have a unique insight into the way the world will look in the future?
- How does their deal flow match that future state?
- How does their investment strategy position them to take advantage of that deal flow?
Put another way: what is the investor’s vision, what are the investable opportunities coming the manager’s way, and how is the investor capitalizing on those opportunities.
Below is more detail on each element of the framework.
Does the manager have a unique insight into the way the world will look in the future?
A venture fund is a fundamental bet on what markets will exist and be valuable 5-10 years from now. A fund’s investment thesis is the description of the manager's vision on the type of companies that will shape those markets and define the future.
The best example of this is the investment thesis from Andreessen Horowitz’s “Why Software Is Eating the World.” This seminal memo articulated how the world has fundamentally and unalterably changed due to the proliferation of software. It discussed why a16z believed that this trend would continue and what changes it would bring.
Not every manager needs to plant a flag in the Wall Street Journal, however, a clear, well-defined theory of change establishes the first layer of an edge.
Does a manager’s deal flow accelerate that future state? If so, what makes it unique, defensible, and resilient?
After an established vision, I have to understand what deals a manager sees that relate to their thesis. The companies they have access to need to match their view of the future as deal flow is the gasoline that fuels a fund’s process.
However, access to early stage deals is not as gate-kept as it was in the past. With platforms like Stonks, there is much more visibility into companies that are raising. Platforms like this are very useful for angel investors but, as a fund builder, they serve as competition and can weaken a manager’s personal approach.
Having unique, defensible and resilient deal flow is therefore critical to developing an edge.
- Unique in that no one else has it.
- Defensible in that others cannot easily access these deals.
- Resilient in that it is sustainable over time and matches the thesis. This can manifest in the form of partnerships with natural sources of entrepreneurship, a technology platform, or a truly powerful and long-standing community.
How does a manager’s investment strategy position him/her to take advantage of that deal flow?
The last aspect of my framework seeks to understand how the set strategy assesses the deal flow, applies the vision, and translates into an investment decision.
Essentially, I am asking what the manager will say “no” to and what constitutes a “yes” for him/her.
The “No” should be set out by the thesis. Anything outside of it should be an immediate pass.
The “yes” is far less clear. Not every company, founder, or idea that fits within a thesis represents a good investment decision. As an emerging manager—with limited capital and extreme scrutiny on every decision—this is a very difficult process to build. It relies on the manager’s diligence and detailed understanding of the markets they invest in. Therefore, getting it right over time is critical.
Conclusion
An “edge” is not an objective item.
Different LPs will evaluate different managers, well, differently. However, working within the vision, deal flow, and investment decision framework communicating defining an edge becomes easier.
