As we at Saison Capital looked back at our LP winners, and improve on LP strategies moving forward, we were particularly excited by the rise of first time GPs, and micro-VCs [defined as <150m].
Below is an early framework we initially developed for thinking about LP investments and introducing 3 categories of VCs within early-stage GPs that guide our LP investment framework.
Within early-stage GPs, we found 3 buckets of GPs that existed:
Category #1: Mass portfolios (“Spray & Pray”)— w/ 1–3% ownership — typically 100k-200k ticket sizes, with 20 to 80 companies per fund
Category #2: Large Coinvestor — w/ 5–7% ownership — typically 500k — 1m ticket sizes, with 15 to 30 companies per fund
Category #3: Lead Investor capabilities — w/ 10–20%+ ownership targets — typically 750k — 2m ticket sizes, with 15 to 25 companies per fund
(Actually 20%+ was historically the target but that’s now been seriously pressured downwards and a topic for another day)
We also think it is important to overlay an ownership strategy by fund-size.
Category #1 investors are most typically found under the $50m mark
Category #2 investors are most typically found above the $50m mark, up to roughly $100m
Category #3 investors are most typically found between the $75 to the $200m mark [Approximately the upper limit for Seed funds]
GP’s are optimizing for meaningful ownerships at exit for great companies. As articulated by Rob Go from Nextview, this means:
Investing in the right companies. It’s more important to have only “ok” ownership of a great company than great ownership in an “ok” company.
Having disproportionately high ownership relative to fund size, especially compared to your competitive set. This may mean NOT having higher absolute ownership.
Being able to have high ownership at exit.
This is accepted truth. The remaining question is how one gets there.
For a VC fund, ownership strategy is probably one of the main drivers of our business model. So it’s strange that there isn’t more variability around ownership strategy given the variability in fund sizes in the market — Rob Go, Nextview
With the above categorization of 3 buckets of investors, we are now clear that fund ownership strategies do exist and vary according to AUM.
While there are many reasons for LP s to invest [Growth funds looking for access, FOs looking for early-stage exposure, HNWIs looking to be in-the-know, etc], we will focus on thinking about optimizing for long-term financial returns across repeat funds for the same GP, what Oper8r has helpfully termed ‘Generational Fund Returns’. Oper8r has a much more beautifully written framework on LP incentives here.
As financial opportunities, LPs should take all 3 categories of GPs seriously. Category #1 investors in particular are typically overlooked by LPs, but should be expected to be more prominently featured in the LP market as investable GPs, empowered by the general breakdown of cultural and technical friction of quick smaller cheques by operators with early-stage access [through Angellist syndicates, etc].
Category #1 “Mass Portfolio” funds scale not by AUM, but by number of investment partners [which then scales AUM] as they attempt to overcome the structural disadvantage of maintaining their value-add reputation while managing a significantly large and diverse portfolio.
Category #2 and #3 fund profiles are typically ex-operators/VCs with a very clearly defined value proposition that justifies their allocation alongside Tier 1 branded VCs.
However, the long-term capital provider who is looking for multi-fund exposure should expect to see a GP strategy that clearly shows their ability to move up the ownership target ladder, and track the performance of such a strategy over time/ subsequent funds.
Specifically, GPs should be prepared to articulate how they can move upwards as a Category, from a Category #1 or Category #2 investor or a Category #2 to a Category #3 investor.
Just like in every other part of finance, different VC fund sizes require different strategies, and one would want to see if the investment strategy and investor skillset can scale with AUM. The skillsets required to be Category #1, Category #2, and Category #3 investor differ greatly.
The reason LPs should expect the push up the ownership ladder is to avoid the structural difficulties of attempting to maintain value-add reputation with hundreds of portfolio companies, while increasing one’s ability to pick and maintain large ownership stakes in top-performing companies.
For Category #3 investors, there is no necessity to actually lead a deal if one can guarantee a certain allocation. As Rob pointed out, the benchmark should be an ability to win ownership relative to fund size. However, it remains difficult to see how an investor can systematic own large allocation stakes without being a lead investor. Further, as the fund size increases, it is generally unlikely for large ownership stakes in large rounds to be held by non-lead investors. Leading great deals also generally provides a signalling effect that allows GPs to win and lead the next great deal.
Many institutional LPs would additionally enjoy the ability to put more capital to work by deploying larger and larger ticket sizes into their existing GPs.
There are situations where GPs can and may prefer to remain a Category #1 and Category #2 investor. Correlation Venture-type funds, Super angel funds, Angellist syndicate funds, specialized pre-seed funds, specialized venture builders, etc are among the funds that typically have no desire to increase the Assets managed [AUM]. These funds would be an exception to the above framework and may represent great financial opportunities if the LP is clear that there is no desire to put larger and larger capital to work.
P.S.: I want to especially highlight the ‘venture builder/super angel fund’ exception. I have seen a number of renowned ex-founders starting small <50m funds and venture-building/incubating startups with high ownerships [15–30%] (therefore falling out of the Category #3 investor model).
As a big fan of venture building/incubating myself, I think these are great financial investments but rely on very specific profiles to generate outsized returns. As a niche category, I have also left them out of the categorization. I also believe that while not impossible, there exist structural challenges to scaling that model in terms of AUM.
What skill sets are best suited for each category of investor?
Category #1: The most common Category #1 investors tend to have the most clearly articulated value-proposition, typically in a niche tactical role [i.e. talent, tech, product, etc]
Their main competition is other angel investors, optimizing for the highest help-to-cheque size ratio.
Category #2: The most common Category #2 investors tend to have a clearly articulated value-proposition, typically in a more strategic role [i.e. deep expertise in a particular industry]. Category #2 investors tend to be vertical-expertise/biased.
Their main competition is other Category #2 investors and being squeezed by Category #3 investors.
Category #3: The most common Category #3 investors tend to be investors that have a deep Rolodex among growth investors, and prior experience leading hotly contested deals, with ex-Tier 1 GPs commonly featured.
Their main competition is other Category #3 investors, particularly Tier 1 branded lead investors.
At Saison Capital, when deploying for our LP strategy, we tend to look for:
1. Type #1/2 investor, < 50m, with a potential to graduate to an upper category
2. Type #2/3 investor, 50m-150m, with a potential to graduate to an upper category
With the smallest fund backed by Saison Capital being 6M at the time of backing, and with our first US LP cheques deployed, we are excited about the early stage GP landscape over the next few years.
We are still doing more thinking about optimal LP allocation.
If you are a GP with an exciting background/fund strategy, other LPs, or LP advisors doing thinking around micro-VC strategy, I would love to chat at email@example.com.