The Genesis of Venture Capital Funds

“A first time fund is acceptable, but not a first time investor” — Mahendra Ramsinghani, Secure Octane Investments

The world of Venture Capital is a numbers game where the funds with the most complementary teams, the best access to opportunities and the greatest tools to support their portfolio companies have been the big winners. Of the nearly 2,000 Venture Capital firms in the United States, only 5.6% have more than USD$1bn of assets under management, with the main players in the market being firms such as a16z (Andreessen Horowitz), Lightspeed Partners, Sequoia Capital, Bessemer Venture Partners, New Enterprise Associates (NEA), among others. This trend is also repeated in emerging markets, where only a few funds have been the big winners; for example, in Latin America there is no startup that does not seek to pitch to Monashees and Kaszek, while in Asia the most reputable funds are SOSV, East Ventures, Tiger Global Management, or even the investment arms of recognized firms in the United States, such as Sequoia Capital India and China, Lightspeed Partners India and China, GGV, among others.

To understand the success of these investment firms, one must understand how they were formed. The genesis of Venture Capital funds takes three main forms:

A. Founders with an entrepreneurial background

Some of today’s flagship funds were born from individuals who were entrepreneurs. For example; a16z (Marc Andreessen co-founded multiple internet companies, such as Netscape) and Kaszek (Hernan Kazah co-founded MercadoLibre). The common characteristic is to have created a company, grow it and position it in the market as a relevant startup. As a fund, their value proposition is to focus much more on entrepreneurs and support them according to their previous experiences. Some of these fund managers have been able to develop investment skills and achieve outstanding returns.

Being an entrepreneur and setting up a Venture Capital fund does not ensure that the investment vehicle will be successful. There are many skills required as a Venture Capital investor that entrepreneurs do not have. According to CB Insights, of the top 100 VC firms in 2017, only 38% of their managers were entrepreneurs in the past.

B. Managers with VC investor backgrounds

The second classification of Venture Capital funds is those who have an investor background, and have the skills of analysis, structuring, formation and portfolio management. These fund managers seek to create a team that offers differentiated value to startups, from product enhancement to introductions with potential customers and investors. Eric Archer, co-founder and Managing Partner at Monashees was trained as a Venture Capital investor at the renowned U.S. firm, General Atlantic. On the other hand, Rob Stavis, Partner at Bessemer Venture Partners has over 20 years of Venture Capital investment experience and prior to that spent 14 years developing his career at the investment banking firm Salomon Brothers.

As with entrepreneur-founded firms, no correlation has been found to date between the years of Venture Capital investment experience of fund managers and fund performance.

C. Managers with hybrid entrepreneur/investor experience

Sometimes an entrepreneur and a person with investment experience join forces to found a Venture Capital fund. This complement is attractive as they join forces combining their experience, knowledge and business networks. Some examples of these are: The Venture City, a Miami-based VC firm, where one of the co-founders spent more than 11 years developing early-stage technology companies such as Facebook and eBay, while the other co-founder was a partner in a financial services boutique for almost 20 years before joining Venture Capital. Another clear example of this category of funds is B Capital, an investment firm associated with Boston Consulting Group, which was founded and is managed by Facebook co-founder Eduardo Saverin and Raj Ganguly, a professional with more than 20 years of experience in the strategy consulting and Venture Capital industry. This combination can be explosive, obtaining better results than the first two alternatives, since it brings together the portfolio building skills of one of the managers, with the empathy and understanding towards entrepreneurs of the other manager.

In the life of a Venture Capital fund, the experience and reputation of the founders is not everything; there are multiple factors that must be taken into account to be successful and transcend within the ecosystem, for example:

  • Investment thesis discipline and track record: it is important to build a track record with robust and outstanding returns during the life of the fund. Having unicorns within the portfolio is relevant for Venture Capital funds, as they can return the full value of the fund. The most recognized Venture Capital funds are those that have more unicorns in their investment portfolios, also called Unicorn Hunters. Among the most prominent funds in this category (as of May 2019) are: Tiger Global Management (32+ unicorns), Tencent (30+), Softbank (28), Sequoia Capital China (25), Sequoia Capital (23) and Kleiner Perkins (20).
    - Disruptive investment thesis: Usually the funds that manage to grow and be winners are those that have innovation and disruptive technologies in their investment philosophy. They only invest in startups with novel business models and a vision for the future. A clear example of this vision is the one Marc Andreessen had in 2011, when he published his essay “Software is eating the world”.
  • Brand building and growth: The success of a fund is the generation of a brand that transmits confidence to investors, support to entrepreneurs, and impulse to the Venture Capital ecosystem.
  • Pipeline generation: This is one of the main characteristics of successful fund managers. They have the ability to generate their own pipeline, supported by their brand, their networks and their knowledge of the ecosystem. In order to build a portfolio with 1% of the most outstanding startups, a fund must see around 3,000 startups during its investment period, thus building a selective portfolio of 30 companies.
  • Strategic relationships with GPs: The VC ecosystem is the aggregate of participants, and as such, a manager should forge long-term relationships with other funds, considering them allies, not competitors. This will allow you to access better investment opportunities and be able to sell to the startups in your portfolio more easily.
  • Building long-term relationships with LPs: Without capital there would be no Venture Capital fund. Limited Partners are the fuel that drives the Venture Capital ecosystem. They have a long-term vision and their job is to find the best fund managers for above-market returns.
  • VC funds are organizations made up of individuals, if there is no focus on organizational development, the organization is not destined to endure. Individuals pass, organizations endure.
  • Funds should establish robust investment processes, so that they can better choose their investments, and give entrepreneurs more visibility and understanding of the process.
  1. Limited entrepreneurship ecosystem: The triggers for innovation and entrepreneurship in Mexico are scarce, with limited government initiatives and few universities that encourage a culture of entrepreneurship in society, which causes the few opportunities to create a potential unicorn to be highly competitive among only a few funds.
  2. Lack of professionalization of the industry: The practice of Venture Capital in Mexico has not been professionalized, and few funds have managed to raise multiple investment vehicles over the years, which has also caused the raising processes to be very late and complicated.
  3. Regional and global competition: Although Mexico is the key market for any startup looking to expand into Latin America, there is increasing competition from VC firms in Brazil or the United States that have the ability to offer a more attractive value proposition to entrepreneurs in terms of experience, contacts and capital.
  4. Portfolios without global vision: Investment theses and strategies are very regional, with very few funds trying to find opportunities in other countries. This limits the ability of local funds to identify truly innovative and disruptive opportunities.

Venture Capital funds are undoubtedly key to the development of new companies, but beyond capital, they must focus on offering a differentiated proposition to the LPs and startups in the portfolio, through differentiated teams, building business networks and robust and lasting relationships that generate a reliable brand. At the end of the day, only funds with vision, commitment and long-term team development are the ones that will be able to compete in the global Venture Capital ecosystem.

Note: please refer to the original publication at EL CEO: La génesis de los fondos de venture capital (elceo.com)

Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.

Gonzalo Soriano. VC Investor at ACV.

ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.

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ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.