GenuineVC

Critics of Micro VCs have been quick to point out one primary difference vs. the traditional VC model as a significant flaw: the rapid capital deployment velocity.  In other words, if Micro VCs are investing in an accelerated pace where they make at least a handful of investments each year per investor, then perhaps they aren’t doing the sufficient amount of diligence to truly vet these opportunities.  Is the Micro VC approach merely just “spray and pray”?

The key issue to examine with respect to diligence speed is the distinction between diligence process time and the time expended during the diligence process.

During the seed stage where Micro VCs invest, there are three primary diligence factors:

1. Team and individuals – The information discovery here involves conversations with former coworkers, cofounders, partners, investors, and customers.  These people can validate and reference the abilities and integrity of the team involved in a venture.
2. Market size validation – Part of this inquiry involves research and part relies on gut instinct based on being a domain expert in a space.  By focusing on one domain, an investor can make instinctual decisions based on accumulated knowledge in addition to analytical decisions based on recently gathered information.
3. Customer hypothesis gathering – Depending on the startup’s offering, these efforts involve calling potential customers which are end-users of a product, or understanding any early key usage metrics the startup may have already developed.  On pre-launch consumer services, again the diligence partially rests on an investor’s instinctual pattern-recognition based on experience and understanding following a specific market.  (Afterall, Henry Ford said, “If I had asked people what they wanted, they would have said faster horses.”)

#2 & #3 above can be diligenced systematically, but only to a modest extent at the earliest stage of a company.  If the initial gut-checks aren’t there, then an investor isn’t going to spend time on diligence.  At the end of the day, it’s all about #1: the team and ability to execute.  The diligence on the team can be completed fairly rapidly, and is often already partially completed if an investor has a solid previous relationship with the entrepreneur founder or was referenced to him from an extremely trusted source.

In comparison, for a typical Series A investment, an investor needs to diligence all of the above plus also:

1. Validate venture-scale opportunity.  This effort is the least talked about, often the most difficult to discern, and truly a top priority.  Although similar to #2 above where an investor is determining if there is a real market to go after, the distinction here is that given the post-money of a Series A is higher than a Series Seed round, the expectations of what will constitute a viable return potential for a new investor increases in step.  A Series A investor must determine if both the exit opportunity and the company’s capital requirements match the size of their fund, which becomes more challenging as those figures go up in absolute terms.  In other words, for traditional Series A venture investments, the exit outcome usually requires forecasts to in be the multi-hundreds of millions and the capital expectations are often $10M+ for a larger fund.  These (relative) constraints are less inhibiting for Micro VC because of ability for these firms to win at smaller scale outcomes (even though they are also shooting for and enjoy the success of big wins).  For new investors, thinking though the math for each opportunity takes time, especially as the absolute dollar figures involved go up the relative probability for a larger outcome decreases.
2. Call initial customers/ reactions.  Once there are meaningful customers/users and metrics to diligence, an investor should call these parties to fully understand the opportunity and service.  While not difficult, these calls add an additional layer of process.
3. Justify the investment internally.  Given the capital constraints of smaller fund-sizes (and in turn fee structure) that Micro VCs face, by definition these firms have fewer people (if even more than one at all).  Less people in a firm translate directly into less internal communication time.  At one extreme, if a Micro VC is truly a sole super-angel, then he makes an investment decision and acts immediately.  Even in a small partnership focused on a specific space and sector, education and buy-in for a particular investment opportunity can happen rather quickly.  The relationship between number of investment professionals and time spent on internal justification isn’t a linear one, but rather a geometric one based on the number of communication links between people nodes.  The larger the firm, there is real potential for this step in the process is just that… process.  The cycles of internal deliberation and justification aren’t really diligence, but do take up significant time under that label.  And often there is risk that the bulk of the “diligence” period is internal justification politics rather than legitimate inquiry and investigation.  This extra layer of process can be further exaggerated if a firm operates with a leveraged resource model (analysts + associates + principals + jr. partners); or a multi-stage, a multi-sector, or a multi-country investment strategy.  In those cases, a certain subgroup operates with a fundamental knowledgebase given their specialization and there needs to be further internal education about a specific set of assumptions on any given opportunity.  In contrast, MircoVCs are either sole super-angels or small partnerships where this step is non-existent or minimized.

While Micro VCs posses the ability to employ an efficient yet thorough diligence process, it certainly does not mean that all quick diligence periods are thorough and exhaustive ones.  It should be cautioned that even though a Micro VC has the capability to be both quick and yet exhaustive in diligencing an opportunity, it is incumbent on them to act as such.

But given the dynamics at play, a real careful and systematic diligence process appropriate for the seed stage need not (and should not) take as long as a full scale Series A investment.  Quicker diligence is not lesser diligence at the seed stage for Micro VCs.


Micro VCs are notorious for building large and friendly syndicates.  One or two players decide (sometimes rather quickly) to make a seed-stage investment in a new startup, and as a round comes together they invite in a number of their Micro VC and angel cohorts.  What’s the reasoning for all of this chummy behavior?  While traditional VCs sometimes have a love/hate relationship with their syndicate partners (often depending on how well their mutual portfolio companies are performing), it seems as though in the Micro VC arena all of the players speak and act like best friends.  Can this friendship last forever?

Just like traditional VCs, Micro VCs syndicate to pool their risk and their (tangible and intangible) resources in maximizing the upside of the investment while hedging the downside.   Therefore, the most obvious reason for Micro VCs to syndicate more prevalently is due to capital constraints.  When a Micro VC is working from a relatively smaller pool of capital (usually less than $25M per partner), it would prefer to spread risk out further.  Plus, unlike traditional VCs which have capacity to invest over the life-cycle of the startup, Micro VCs can usually only afford to play for a round or two.  Or not even a full round in many cases.  By definition MicroVCs need each other.

However, the friendly nature of syndicates is not just dictated by capital constraint, but deal sourcing and velocity as well.  Perhaps implicit in Micro VC model is the aim to potentially maximize the number of good deals to deploy capital, as opposed to maximizing the amount of capital deployed into a number of potentially good deals.  Given the number of deals that they do each year, Micro VCs more actively turn to their peers for deal sourcing.  This situation is further exaggerated by the smaller funds they manage which result in less management fees.  Without additional cash flow coming into the firm, Micro VCs lack the ability to hire associates or other support to provide leverage on deal sourcing, so they instinctively turn to their fellow firms.

This reliance on outsider syndicates for deal flow does present risks for Micro VCs.  Outsourced deal sourcing shouldn’t be confused as outsourced deal diligence – a potential fatal flaw which does certainly happen.  Playing nicely in syndicates is not reliable due diligence, period.  This group-think effect also fosters a negative situation for entrepreneurs as well.  With Micro VCs building syndicates in familiar packs, a cursory investment decision by one group-member can spread quickly.  Somebody passes in a clique, and soon an entrepreneur is receiving an automatic “no” from the rest of the network of informal ties.

The third reason Micro VCs travel in overly-friendly packs is that the Micro VC space is relatively immature, so the supply of good investment opportunities is still outweighed by the demand.  Almost all of the firms or quasi-firms are just a couple years old.  As the Micro VC space matures and there are additional entrants in the market, potential competition for getting into deals and more capital in each will increase.  This evolution will drive up the “price” of getting into good deals and the chumminess will be dampened.  

Moreover, as some Micro VCs experience success and decide to change strategies by “growing up” into traditional VCs, their capital constraint goes away.  So players who were friendly originally may be less so down the road.  Yet just as traditional VCs are face their peer firms as coopetition, this situation will endure in the Micro VC segment as well.  As the space matures some of the over-enthusiastic pupply-love will be lost.  And if Mirco VCs lose their defining characteristics and become the pigs at the end of Animal Farm, they’ll lose the overtly syndicate friendliness.

But as long as these Micro VC players remain capital constrained and seek a higher deal velocity, they’ll remain good friends forever.  A critical mass of high quality friendly syndicates creates an activation energy for an ecosystem.  Having more smart people giving their time and their resources into a startup market creates a ripple effect of new companies, better performing companies, and ambitious entrepreneurs.  Afterall, it’s good to have friends.

Before I wrote a couple detailed posts on Micro VCs, I thought I’d write an overview one sharing my broad perspective on this portion of the VC world.  It’s clear that despite the varied terminology (Super Angel, Micro VC, Seed Stage VC, Seed Firms, etc.), a new segment of the institutional venture market is emerging.  Both super-angels are institutionalizing “up” and formerly traditional VCs shifting “down” to fill a market opportunity.  I think that the number of players in this devloping class of what I’d call “Micro VCs” will continue to increase over the coming years: the model fits into an opportunity on the capital supply side, as well as more importantly becomes the right product for many entrepreneurs on the demand side.

First, it’s helpful to provide a definition.  Micro VCs will continue to come in many flavors with slightly different strategies, but there are a few distinctive defining characteristics:

1. On a per partner basis, each investor is investing less than $25M in any given fund
2. The capital deployment velocity is notably higher than a traditional 1-2 investment per partner per year.
3. Initial investment in a company is among the first non-founder capital raised.
4. The firm is solely focused on capital efficient business sectors, most frequently but certainly not always internet-enabled companies.
5. Portfolio construction favors early-round capital allocation vs. company life-cycle allocation.

(The catalyzing forces which have facilitated this phenomenon have been enumerated in many places within the blogosphere, including a post my partner at NextView Ventures, Rob Go, wrote on “Making Sense of Micro-VC’s and Super Angels.”)  However, it’s important to highlight that some of those causes are potentially temporal while others are strictly structural.

Temporal.  On the supply side, VC firms spent the previous decade raising increasingly larger funds.  With the fund sizes going up, it logically followed that, when utilizing the same playbook as they had been for previous decades, the amount of capital VCs invested in first institutional rounds went up.  However, we’re in the midst of a VC fund-size correction with a number of firms recently raising funds sometimes half the size of that of a few years ago.  Yes, a number of GPs departed along with those downsizings so that the per-partner investing capital change has been less pronounced, but I’d postulate that the downward pressure in traditional VC fund sizes will manifest in classic Series A round size leveling or even shrinking over the coming years.  So while the early emerging MicroVCs have been able to capitalize on a short-term market phenomenon in the VC capital supply profile, there’s an outstanding question how pronounced this dimension of the market will hold.  That being said, in a world where $800M funds transition towards $400M funds, they remain distinctly different in magnitude from a Micro VC even if the fund sizes converge on a relative basis.

Structural.  However, the causes of the Micro VC trend are more substantially attributed to the entrepreneur demand-side of the VC equation.  In the sector of internet-enabled services where a majority of the Micro VC investment has transpired, startups can fundamentally do more with less.  That’s no secret.  Of course CapEx has been transformed into OpEx via changes in the tech infrastructure layer (open source, virtualization & cloud computing, offshoring, etc.).  But leveraged distribution via platforms (organic/paid search, social networks, mobile devices) and self-service monetization (ad networks, app stores, payments) is what has truly empowered startups to become real scalable businesses on very small amounts of initial capital.  All of these above changes aren’t just due to market inefficiencies (like the supply side), but are truly marked changed that are intensifying.

So when the best entrepreneurs need less capital to start their companies, they’ve historically turned to angels for their initial funding.  However, the drawbacks to angel investors are clear – given the lack of professional approach and limited capital capacity, these individuals are frequently less willing to lead rounds and require numerous investors for an entrepreneur to build a sizeable round (and manage subsequently).  The traditional VCs which have recognized the demand-side issue have launched numerous (sometimes high-profile) separate special programs and initiatives to play at the seed stage, to varying degrees of success.   The fundamental issues center around the tension between their capacity and willingness to lead/participate in successive rounds (which has been discussed extensively elsewhere) and a diligence process/timing mismatch given the investment-level.

With a new third option available, some of the best entrepreneurs are increasingly turning to Micro-VC asset class for their initial investment.  With that choice, they’re maximizing their full Series A options, potentially reducing ultimate founder dilution, and retaining flexibility for strategic options (including exit) along the path – all while raising money with a more efficient diligence and decision-making process.

Yes, “seed-stage venture firms” have always been around.  The difference now is that given the structural changes in the market, seed-stage investors are more likely to be rewarded in valuation given the value which is created during this segment of the company’s life cycle.  Startups are now able to produce real meaningful early business traction which yields genuine valuation increases, not just a prototype or proof-of-concept which yields merely a ticket to another round of dilutive financing.  During an initial seed round, companies are able to test and validate live product/market theses.  These results are based on actual usage of product by early users, with resulting operating metrics which more than just validate a hypothesis.

Seed-stage firms and super-angels institutionalizing are now more appropriately called Micro VCs.  They are no longer just about the seed of an idea, bur rather they have the ability to make small bets which pay-off in large amounts… just like traditional VCs do.  The real defining component of these firms isn’t the seed itself, but rather that these institutions start micro on the path towards developing transformative companies like their traditional VC brethren.  Small checks now have big power.  Seed VC firms are dead… long live Micro VCs.


I thought I would share a quick update on my blog about my professional plans.  With the support and encouragement of my Venrock colleagues, I am pleased to share that I am moving on to co-found a new Micro VC firm focused on seed internet investments.

I am excited to remain on the Board of Directors for Venrock’s portfolio company BlogHer.  I believe that the company is dramatically changing the face of women’s-focused media with an authentic & powerful community of bloggers, and I am happy to continue to be a part of that endeavor as it grows.

In addition, I will also continue to independently operate the Web Innovators Group.  It’s been amazing to facilitate an event which has grown from a couple of us gathering informally in a Cambridge bar to become the “the biggest ongoing tech gathering in town.”  Thanks to the support of our current sponsors Microsoft NERD, Gesmer Updegrove, and Silicon Valley Bank, the event will not only continue to thrive but also evolve.  The next gathering to be held on September 13th, and I’ll post the registration page soon.

My new partners, Rob Go and Lee Hower, and I are very enthusiastic about starting our new firm, NextView Ventures.  The three of us believe that there is a compelling market opportunity on the east coast for a new seed-stage venture capital firm for founders starting internet-enabled businesses.  We too are entrepreneurs at the very earliest stages of starting; as things coalesce we’ll announce the details and launch.  To the extent you’re interested in learning more, I’m happy to connect personally on it.  Stay tuned for more to come.

I had coffee with an entrepreneur friend the other day who is in the early stages of putting a company together, and he recounted how his informal conversations with a venture capitalist had quickly escalated into a full partner pitch in just a few weeks. That situation sounds very positive in theory, but the problem is that this founder wasn’t ready for this interest and is trying to play catch up in other capital raising discussions (with both angels and VCs). He lamented that if the meetings with this venture firm soon led to a term sheet, he’ll be faced with a tough problem of a binary decision – take whatever they offer him (which was likely too much money for what the company needs now at not a great price) or risk losing any funding options. A high class problem, certainly, but one in which the entrepreneur could have easily avoided by generated alternative funding options and as a result, a better outcome. I’ve seen this scenario play out often; as VCs are aggressive in pursuing hot new companies and entrepreneur (especially first-timers) are flattered and eager conversations with VCs. Given this situation happening, I’ve even heard some people strictly advise entrepreneurs never ever to talk to VCs unless they absolutely need to… in order to raise money.

All of this led me to think about the question – when is a good time for an entrepreneur to talk to a venture capitalist?

At the recent March Web Innovators Group event, I invited a panel of serial entrepreneurs to talk about their founding stories, during which David Cancel said that “one of the most unproductive things new founders do is talk to investors too early… I test all my ideas on the web.” I completely agree that the best way to test market demand for a business is with customers, and spending too much time with investors early on can be unproductive. Recently Chris Dixon wrote that in developing new startup ideas that founders should be the “opposite of secretive” and talk about startups ideas with “every smart person you can get a meeting with”… including VCs. He continues “VCs are good at telling you about similar companies in the past and present and critiquing your idea in an 'MBA-like' way: will it scale? what are the economics? what is the best marketing strategy? I would listen to them on these topics but pretty much ignore whether they think your idea is good or bad.” Fair enough.

Like most things, knowing who, when, how much, about what, and how often to talk to VCs about your startup is not clear-cut. As a guiding principal, I believe there is a distinction between informal discussions with an individual venture capitalist and formal capital-raising with a venture capital firm. Of course, as an entrepreneur you’re always selling to all of your constituents, including (potential) investors. But I think there’s a bright line between socializing your startup with one person and formally presenting your startup to a firm’s partnership (or a subportion of it).

First, I thought I’d enumerate a quick list few reasons and benefits in talking with venture capitalist before you’re actually ready to raise institutional capital. I am sure there are additional ones. An early conversation with a VC is a great way to:

1. Hear another smart person’s gut reaction opinion. Venture capitalists hear numerous startup ideas, benefit from the ability of pattern recognition, and can share that understanding. Of course, it’s important to incorporate knowledge of VCs’ biases into the feedback, but that’s true in any conversation you’re having about your startup.


2. Learn a top-level perspective of what’s going on the market and how your idea fits into that space. Many VCs closely follow specific industries and subindustries, and have been for a while. Especially if it’s an entrepreneur is exploring in a somewhat unfamiliar territory, a VC conversation can help add to an entrepreneurs understanding of the market.


3. Make connections to people who will be able to improve your business in some way. VCs spend a good portion of their time networking and interacting with a variety of people within the startup ecosystem. Chatting with a venture capitalist could lead to warm introductions to advisors, industry connections, other entrepreneurs who have worked on similar endeavors in the past, potential partners, etc. If a VC thinks an early-stage company has promise, he’ll want to help out in some way to prove his “value add” worth, and providing introductions is a easy one.


4. Receive feedback on when or even if the company will be ready for institutional capital versus private angel investment. Many entrepreneurs I speak with who are starting a company don’t fully understand some of the differences between the capital sources, the ramifications of raising from either, and when (or even if) in a company’s life-cycle it is appropriate for venture capital. Having one or two early discussions with VCs can help clarify those scenarios.


5. Obtain important value-creation milestones from an investor point of view. Similarly, an experienced venture investor can share valuable thoughts what achievements and traction points a startup must reach before it becomes attractive to an institutional investor.


6. Establish a relationship and assess fit. VCs like to fund people that they know, so if you can develop a real connection and dialog with him before you’re actually out fundraising, it definitely aids in that process. And more importantly, an entrepreneur can use (an) initial informal conversation(s) to get a sense of if there’s a match, both in investment profile and intangible interpersonal dynamics (i.e. personality fit).


7. Demonstrate your ability to execute. The best way to sell a VC on your startup is to tell them what you want to do and how you’re going to do it - then actually go accomplish that plan. It’s much better for an investor to “see a movie rather than the picture” as a way for him to assess the capacity to perform. An early conversation empowers an entrepreneur to set goals and benefit from achieving them. VC deal with a lot of startups, so they are very aware that plans and timing do always change. Having a relationship with a VC allows him to understand why those changes happen to see (and get excited about) the accomplishments as they happen.

In many ways, the old adage is very true: the best way to receive funding is ask for advice, and best way receive advice is to ask for funding. So I do believe there are real benefits to informal conversations with VCs before you’re really fundraising – in moderation. After all, entrepreneurs have a company to build. And venture investors are just one of the many many different constituents that are important to speak with early in a company’s lifecycle.

However, it’s important to realize that as soon as you present your idea to another person within the firm beyond your primary contact, you’re officially fundraising. This situation means that your best foot should be forward. At this point you’re not seeking feedback and help, but rather you’re seeking investment. And if you’re looking to optimize the outcome of a fundraise, you should be talking with more than one capital source.

Some would argue that if you’re talking with VCs that your company will develop a reputation in the marketplace of being “shopped around.” But again, I would draw a distinction between individual conversations and presenting to more than one person at the firm. Scuttlebutt in the marketplace is just that, and is a reflection on reality. If you really are actually fundraising for a long time then that reputation will indeed develop; but if you’re truly seeking open advice/feedback/input/connections, that will resonate instead especially if you set those expectations in the conversation.

So what is the entrepreneur at the beginning of the post doing facing his situation? He put the full partnership pitch on hold and is starting a real fundraising process when he is ready.