Conviction In The Winter

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About 2 years ago I was asked by a founder during a pitch meeting, “how long do you think you’ll be in this job?”

It was the first (and only!) time I’d heard that question during a pitch and it caught me totally off guard. It was easy enough to answer (“as long as it’ll have me!”) but when I asked him why, and he nonchalantly replied: “you seem fairly young, so I just wanted to make sure you’d still be around for tough times down the line” I realized: at the point of the pitch, before the first commitment, the vast majority of founders I’ve dealt with (and when I have been fundraising myself) were laser-focused on “getting to yes”. Everything else was just details.

There are a long series of implications to a “yes” from one investor versus another. As a company goes through inevitable ups and downs, needs flat rounds, bridge rounds, inside rounds, and navigates pro rata, the conversation with the venture capitalist will continue, and “having conviction” will become all the more important. Given that we are entering the winter months (interpret however you please) I figured I would frame a few considerations to VC that I wish I had asked, or that a few of our portfolio companies have encountered, which may be worth digging into up front. Needless to say, like with any question, some VC’s may not answer all of these, but they have very serious implications on how a partner feels about the investment in your company.

What is your fund life? When did you close the fund you’ll be investing out of?
Imagine a fund has a 7-year life, and you are in year 3. This means that four years from now, that VC will be downright hankering for an outcome in that investment, even if it is just a 1x return, as they have a responsibility to return maximum possible capital to LPs within the time frame specified.

What is your “reserve” and “follow-on” policy? 
While it may feel incredibly nice to get an easy, price-insensitive convertible note today, if you don’t hit the milestones that warrant a new up-round in subsequent financings, your best bet at more capital will often be an investor already involved in your company. And there are plenty of institutional investors (at the seed and early stage) who don’t reserve, or who only follow-on in up-rounds.

How do you divide your portfolio?
With scout programs, mega-funds investing in seed, small funds doing SPV’s and overages, and the definitional bounds of the business constantly shifting, I have noticed that a number of funds internally think of some investments as “core” and others even as “alpha” and a handful as “research” or “exploratory”. These are all euphemisms in one way or another, and knowing where your investment falls within a fund’s internal calculus can make a difference in what to expect from your investors.

How big is your current fund?
We had a circumstance where a company was going through an exit, and they were realizing that a $250K investment from a $1B fund was *very* different from a $250K investment from a $100M fund or a $250K investment from a $10M fund– in terms of conviction required to get it done, enthusiasm for the company during the investment, and particularly in terms of caring how the preference stack lined up at liquidation. Their first time considering the last point came when they were negotiating the comp with the acquirer. They were shocked by how clearly those differences were playing out in each investor’s behavior.

Do you think venture outcomes are binary? Are they structured that way in your portfolio?
All venture capitalists intuitively believe in the power law and many have seen it play out (the first time it does is frankly astounding). But when push comes to shove, some investors care about ‘singles’ and ‘doubles’ in driving returns to their limited partners, and others don’t. Sometimes this has to do with fund size, as smaller outcomes can be meaningful for investors with small funds, or who have low cost basis of entry. Sometimes this has to do with fund life, as funds that need to squeeze every incremental drop they can at the end of a fund to reach their performance targets. But sometimes it is a matter of philosophy with the venture capitalist. I have seen three different venture capitalists decide to preemptively write-down, double-down, and passively wait out an investment in the same company, in the same round, on the basis of some of these differences.

Conviction from a venture capitalist doesn’t culminate at ‘yes’, it *starts* at yes. “Getting to yes” is just the beginning.

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