A few months ago, Leah Fessler published an excellent blog on things that don’t make sense about venture capital. It inspired me to finally jot down some of my own thoughts on a few of the absurdities of this asset class that I’ve been grappling with for years. Frankly, I have a very long list, starting with the structural barriers to venture investing.
Let’s start with the VC GP perspective. If you are a new GP trying to raise a modest $20 million fund for seed/pre-seed investments, especially for a first-time fund, you will most likely find that the conventional paths to raising such a fund are not as straightforward as they appear. Assuming you do not have an anchor LP who’s open to committing a meaningful chunk of the capital for the fund, you will likely try to raise from either institutions or high net worth individuals.
So you start with institutions. You quickly find out that the majority of institutional LPs (pensions, endowments, foundations, large fund-of-funds, etc.) write minimum checks of $5M - $50M and typically have concentration criteria that preclude them from funding more than 10% of the total fund size. Womp womp. Non-starter for your $20M fund.
Next up: high net worth individuals. You might think, alright, $20 million is a speck of dust within the broader asset management industry, surely I can convince 200-300 people to write checks of $50,000 - $100,000!
Sadly, out of luck again. The driving constraints have way too many caveats and nuances to fit into this blog (I recommend Chris Harvey’s explanation here if you really want to nerd out), but the bottom line is, you most likely won’t be able to accept investments from more than 99 LPs per fund as per regulatory limitations without some major structural gymnastics.
So … you can’t access the trillions of dollars of institutional capital that are allegedly being invested into venture, and you can’t raise from the long tail of high-earning/“rich but not THAT rich” investors. You somehow need to raise $20 million with checks averaging $200,000. For reference, anyone rationally writing a $200,000 check into a single venture fund likely has a net worth of over $10 million. And you need to close 99 of these? 😳
Next time you hear someone bemoaning the lack of diversity in venture and startups, think about these realities:
At risk of stating the obvious, the barrier to entry for new GPs, especially those without prior “top tier venture” experience, is nearly insurmountable and heavily skewed toward those who are already wealthy or have close personal proximity to wealth.
The barrier to entry for LPs who are interested in writing checks into venture funds is similarly high. Even people who are willing to make six-figure investments into risky, highly illiquid assets in order to fund innovation are likely to learn that their money is not good here. This barrier not only limits wealth creation but also sustains the homogeneity of decision-makers and influencers within the venture ecosystem, starting at the top of the capital stack.
Before we break out the world’s tiniest violin for all the aggrieved VC GPs and LPs, let’s talk about the biggest loss incurred: the perpetual dearth of capital dedicated to pre-seed/seed-stage companies. Over time, the few funds that manage to get off the ground & see early signs of success with a micro fund focused on seed investing almost invariably expand into significantly larger fund sizes (and, all too often, larger investment round sizes) in order to access & deploy an institutional capital base. And the earliest stage founders seeking a few hundred grand to a few million dollars? They remain chronically underserved.
Given these realities, here are the things that still don’t make sense to me: Why are most institutions unwilling to allocate meaningful amounts of capital into the segment with the highest potential return within the venture asset class? And perhaps more importantly, why does one of the riskiest asset classes (early stage venture capital) largely contort itself to the constraints & incentives of more inherently -- and rightfully so -- risk-averse capital allocators (large institutions, family offices & ultra-high net worth individuals, who are largely optimizing for wealth preservation rather than wealth creation), instead of creating new structures that foster more accessibility and alignment in GP/LP return expectations?
Thankfully, we are seeing more bottoms-up interest and pressure to drive structural changes than ever before. If anything in this post resonates with you and/or you’re interested in collaborating with us on solutions to these systemic absurdities, please reach out directly: @geri_kirilova on Twitter or geri@laconia.vc via email.