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