The micro venture capital landscape is getting crowded: According to Samir Kaji, Senior Managing Director at First Republic Bank, over the past five years, the number of micro-VC funds has exploded, from around 25 to over 325 today.
The key factor behind this trend is the cloud, which has made it much less expensive to get startups on their feet. As a consequence, small funds can now build sufficiently diversified portfolios as less capital is required at the earliest stages of a company. And while this is good news for entrepreneurs and those starting small funds, the explosion of funds has made it more challenging for investors to identify funds worth investing in.
According to this Kauffman foundation report, small funds have a better shot at providing returns than do larger funds—so finding the right Micro-VC funds to invest with is a worthwhile endeavor. To evaluate a fund’s chances of success, we have to understand what characteristics a fund needs in order to succeed.
Some of the best perspective on this question comes from later stage investors —the investors who take the baton from Micro-VCs, who in greater proportion tend to invest in early stages due to the size of checks they generally write. From speaking with a few later-stage venture investors, I’ve learned that successful early-stage funds tend to share a particular characteristic: They are comfortable challenging convention and consensus.
A case in point: SoftTech VC’s non-consensus approach to FitBit in 2008. Most investors in 2008 were confused about the product, and hardware investing was viewed as a no-fly zone (particularly for small funds due to capital requirements). Of course, we were also sitting in a market that was in its depth of financial crisis. SofTech’s non-consensus approach at the time was to seek a hardware investment that would play out like a capital-efficient software investment. As investing goes, it doesn’t get better than FitBit, which had a monster IPO this past summer and turned out to be a superb bet for SofTech.
Another case in point is Veeva Systems, an enterprise cloud provider for life sciences companies like Pfizer. The company in early stages was neglected because of doubts about a cloud-based platform for a vertically oriented market.Emergence Capital pushed against the consensus to fund Veeva, and benefited tremendously when the company did its massive $3-billion IPO.
Of course, a non-consensus approach is no silver bullet. To understand other ingredients of success, I spoke with Jake Saper, Senior Associate at Emergence Capital. His view was that in order for a fund to be successful, you have to know the space you are investing in intimately, which will enable the non-consensus bets being much more likely to hit.
Jake further surmised that the funds that successfully cut against the consensus don’t chase brands or momentum, but rather immerse themselves in a particular slice of a market. Emergence Capital, for instance, invests exclusively in enterprise software for the cloud. This focus has allowed the fund to build terrific connections and deep expertise.
Industry focus not only helps funds to identify promising startups, but also to connect them with experts, employees and resources that can help them to refine their ideas and ultimately take them to market. As Wesley Chan, general partner and managing director at Felicis Ventures put it to me recently, investors should “look for VCs who hustle and help build companies.”
We can’t know which micro-VC funds will be the most successful going forward. But we can identify those with the right profile to be successful, which leads to two big keys: a) They’re thoughtfully contrarian, and b) they have the focused perspective and immersive knowledge to make good calls and help guide their startups to success.
Disclaimer: This material is the solely opinion of the author and does not represent an official statement by BluePointe Capital Management, LLC, nor does it constitute a recommendation for the purchase or sale of securities. No representation is made on its accuracy or completeness of the information contained herein. Although the information provided is from sources we believe to be reliable, we do not guarantee the accuracy or timeliness of any information for any particular purpose.