Fund size does matter

I caught up today with Foundry’s Jason Mendelson.  I always enjoy connecting with him and his partners.  Both of our groups love early-stage investing, have a partners-only model and have seen many VC cycles.  Foundry’s street smarts also are incredibly impressive.  I learn a lot when I speak with them.

What struck me most about the chat, though, was Jason’s vehement belief in fund size discipline.  Though they have Zynga in their portfolio and can raise any amount of money they’d like, their second fund is the same size as their first. Another $225 million for their four-member team.  “Not a dollar more,” Jason said.

Foundry has made a decision that deserves laud.  You see, VCs get paid 2% to 2.5% annual management fee each year for 10 years for every dollar they manage in a fund.  So, a $1 billion fund, for example, generates $200+ million of fees to the management company (for more on that, click here).  That’s some serious coin.  And, it’s a huge incentive to grow future fund sizes.

Unfortunately, a $1 billion fund forces that VC firm to do one of two things to invest such an amount: 1. massively expand the team, and/or 2. pursue growth equity or leveraged buy-outs, whereby they can write larger checks.  It’s tough to fit start-ups into the mix.  In other words, success often encourages VC firms to exit the business that made them successful to begin with.

At Kepha, we selfishly love working with start-ups.  We have a saying: strategy drives fund size, fund size doesn’t drive our strategy.  I hope we will one day have a Zynga, and if we do, I want us to be able to do what Foundry did, which is stick to our knitting.

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2 thoughts on “Fund size does matter

  1. Dear Jo,

    I have been reading your blog with great interest. First of all, thank you for creating such an open and insightful discussion. A way of long-term “returns” through sharing knowledge, something I fully subscribe to. More on that later.

    Your various posts and the Kauffman report, provide me with a confirmation of my idea of the future for my father’s VC which I have a passion for continuing and transforming into a VC 2.0. My initial focus will be on knowledge transfer and investing in two or three VC’s were I can work closely alongside the partners or even take part in the management company. After this initial period of two to three years, I will start to actively look for direct investments (alongside one or two strategic partners which will have crystalized out of the first two years). From there on, enough track record should prevail to attract outside funding and really professionalize the VC by attracting two or three partners.

    At the moment, at 31 (Wife and two kids), I am standing at an important crossroad in my life. After starting out as a consultant doing things ranging from analyzing railroad usage vs costs, to business case validation and due diligence to smaller M&A work in the Netherlands, I followed my gut and helped start a biodiesel company in Austria in 2007 and attract €30 million in funding for it.
    Although a very interesting time, the business was destined for failure due to declining margins (lesson: think twice before investing in companies whose main reason for existing are subsidies and political will.). Product-wise we were right on the money by producing biodiesel out of used cooking oils, but the debt burden was just too high. Investors lost all their money. Yet, a little light ended up shining at the end of the tunnel as they just bought the same company out of bankruptcy and own 25%, with the remainder belonging to a financially strong partner (trader). I am still close to the original investors and have advised them along the way.

    Having really caught the bug of working for myself, for better or worse, I focussed on finding a distressed company in the Netherlands (my country of origin) which I could turn around and take up a major stake without a large capital commitment. The company is now doing so-so since there is a lack of chemistry and trust between the CEO-owner and another investor. However, again an experience with major lessons learned.

    Now I come to the crossroads. My father started his VC activities in the very early days of 1980. He has never “professionalized” his business and therefore never taken on money from outside parties or hired a staff to support him other then a secretary. He just turned 67 and I want to continue the VC activities, albeit in a different light. Next week I will pitch my ideas to him.

    Best regards and if by any chance you have a suggestion for me, I would be more than thankful.

    Best Regards

    Joachim Laqueur

    1. Hi Joachim, thanks for the note. I have family in Nijmegen.

      I think your idea of learning from experienced VCs is a good one. VC looks easy but is really really hard. It is a pattern recognition business much like medicine. So by doing your “residency” with VCs you will learn from them.

      All the best with your future.

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