First, kudos to my friends at Union Square Ventures. They are great investors, great people and provide awesome support for their companies.
Their recent fund announcement was particularly interesting to me as we discuss this issue at IA Ventures all the time: how to reconcile being a seed/early stage fund focused on extreme returns, while benefiting from all the hard work we do with our companies to help them evolve from Powerpoint to profitability?
One could argue that being first money-in is a great place to be in a winner, even if you get diluted down sharply over time. But I personally believe (as do my colleagues) that there is a point on the efficient frontier of risk/return that is better than the invest-early-but-don’t-follow-on approach of some funds.
We have been trying to come to terms with this conflict, and I think USV’s move is astute and pushes them towards the optimal point on the efficient frontier without changing the character of their investing or putting their LPs in an uncomfortable position. It might be among the best win/wins I’ve seen in the money management business in quite some time.
Here is my take:
Being a seed stage investor is a high-risk/high-reward business, and for those companies that make it through the start-up challenges to become a successful, growing company, the original seed investor should be able to benefit from its original risk-taking by providing next-stage capital. Problem is, even with substantial reserves, it is very hard for early-stage funds to continue financing super-performing companies because the capital required for scaling is often massive.
This assumes, of course, a focused and disciplined fund like USV/Foundry/True (or IA Ventures, for that matter), which doesn’t want its early-stage vehicle to grow too large because of a laser focus on returns. The target return multiple and character of risk posed by Series C/D/E investments is radically different than that of seed/Series A/B rounds, and requires a different mind-set. But given the deep knowledge of the early-stage investor in the business and prospects of a break-out investment, doesn’t it stand to reason that they would have good information and relationship with management to warrant later-stage investment?
I think the way USV did this was especially smart. Bring in a different partner to manage the later-stage activity, protecting the early-stage team from getting distracted on what is a fundamentally different investment process and proposition. Source capital from your current group of investors to avoid potential conflicts. And by all means, create the fund in response to and in conjunction with investors who have supported and reaped the benefits of your early-stage success, and would like to re-up for additional amounts in the same stable of companies originally backed. This stage diversification makes tremendous sense for many LPs, especially since the original investment in USV is an investment in the people and the approach, similar to the way USV looks at its own early-stage investments.
I will be watching USV’s management of this new vehicle with great interest. I think they’re on to something, something all early-stage investors might want to consider in how they structure their funds – and their investment approach.
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