Defining Your Fund Investment Strategy
“Someone is sitting in the shade today because someone planted a tree a long time ago” — Warren Buffet
Venture Capital’s business has grown exorbitantly in the last 20 years. In the United States alone, the industry has gone from 1,000 funds in 2000 with USD$260bn in assets under management, to 2,400 funds in 2020 with USD$740bn. The number of first-time funds that raised capital in 2018 was 55 funds with a total of USD$5.4bn of assets under management, while in 2019 this figure was only 35 funds with a raise of USD$4bn.
The Venture Capital industry has become attractive due to the exorbitant returns that investors can have and the sex appeal that comes with investing in companies that can become great unicorns such as DoorDash, Airbnb, Snowflake, Palantir, etc.
For this reason, there is increasing competition to raise capital, which means that new VC fund managers have to refine their investment thesis more and more. The main elements to consider when establishing it are:
1. Sector
Venture Capital funds usually focus on defined sectors to carry out their investments based on the experience and network of contacts of the fund managers. Such is the case of Innovation Endeavors, F2 Capital and CXO Fund, which focus on Deep tech; Ribbit, and QED focused on Fintech; or Versant, Orbimed and Cowen focused on biotechnology.
Other Venture Capital funds are agnostic to the sector, such as Agnostic VC, Vertex, AVG, Velocity Partners, among others. Venture Capital funds in emerging markets tend to be agnostic for the most part, as the market size is very limited to deploy a sector fund.
2. Geography
The geographical focus of investments is linked to the growth potential of each economy. Countries like the United States or Brazil have enough potential for their local funds to focus on them. However, emerging countries require similar or complementary geographies to invest or expand their portfolio; such is the case of Israeli funds that seek local entrepreneurs with a vision of global expansion.
Likewise, Venture Capital funds usually invest in opportunities where they have a physical presence, which facilitates the due diligence process and investment monitoring. Some funds contract or partner with local players to generate investment opportunities; for example, Sabra Capital in Israel. In addition, they can use the figure of an internal or outsourced scouter in other geographies to expand their geographical reach.
3. Investment stage
An essential part of the thesis is the risk-return profile of the fund. Funds that invest in earlier stages (seed and pre-A) may commit lower investment tickets with the possibility of generating more robust returns. The funds that invest in Series B, C or subsequent will minimize risk by seeking attractive returns.
4. Technology
Technology is another focus in the investment thesis of a Venture Capital fund. Some funds only focus on software, such as Sequoia Capital and SaaStr Fund; while others specialize in hardware investments, for example Uncork Capital and True Ventures.
5. Business model
Startups develop their business models focused mainly on B2B, B2C, and B2G. Sometimes, Venture Capital funds only invest in one of these business models, either because of their experience or because of their network of contacts. Such as Ulu Ventures, which only invests in SaaS models, Accel Partners which specializes in B2B investments, Kinnevik or Balderton Capital who focus on B2C startups, or Born2Grow which invests in B2G models.
6. Data reliant vs Human reliant
There are Venture Capital funds that base their investment thesis on their own algorithms, which allow them to validate the potential of each opportunity using only data science; being indifferent to factors such as the sectorial or geographical focus of each company, as in the case of Correlation Ventures.
7. Leader vs Syndicated
Venture Capital fund managers recognize their ability to lead rounds or participate in syndicated investment opportunities. Usually the most relevant funds will take a lead in the transaction, for example, a16z, Bessemer, Lightspeed and Sequoia. Mid to small sizedfunds often participate in syndicated transactions, for example, Joe Montana’s Liquid2.
8. Generic vs Diversity
Most VC funds are generic; that is, they invest in any investment opportunity without restrictions of diversity. Today, some funds are promoting diversity with specific theses focused on minorities; such as Black Angel Tech Fund, Backstage Capital and Digital Undivided; as well as impact issues such as the environment or ESG-based business models; for example Tin Shed Ventures, Better Ventures or Impact Engine.
9. LP based vs Crowdfunding
Usually, VC funds are made up of institutional Limited Partners who are the ones that provide the capital to invest. However, there are other funds that raise capital through a collective funding structure. This gives “retail” investors the opportunity to get involved with a lower ticket, some examples are Ourcrowd, iAngels, among others.
10. Closed funds vs Open ended (Evergreen)
In general, VC funds have a specific life span, which is divided into an investment period and an exit period. On the other hand, there are funds without a specific period of operations, better known as evergreen funds, which are kept in a constant process of raising capital, investing and reinvesting it. Such is the case of Maverick, Thomvest Ventures, among other.
11. Direct funds vs Funds of funds
Similarly, funds can make investments directly and indirectly; direct investments are made through the vehicle itself in startups, on the other hand, indirect investments are made through other funds by acting as Limited Partners. For example, Vintage in Israel, RSJ Tech, among others.
12. Funds with unique channels
There are also funds that only invest in an origination channel, the most common cases are those whose strategy is based on having access to Y Combinator companies. This is possible since the fund managers participated in a program or have invested in multiple companies of this accelerator (ej. Investo)
13. Direct funds vs Opportunity funds
Established funds, with multiple portfolios and a solid track record, are capable of raising subsequent funds to invest in later stages in their own portfolio companies. With this they have the opportunity to invest in those companies that really have a solid step in their portfolios. Some examples are Monashees, KasZek and Valor in Brazil, and Lightspeed in the United States.
The Venture Capital industry is getting wider and more competitive, with more startups emerging and more funds committing capital, making it harder to find the next unicorn. That is why those who want to enter the industry must have an unique and differentiated investment thesis to increase the chances of success within their portfolios and be able to raise multiple funds over time.
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Gonzalo Soriano. Investment analyst at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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