11 Things I've learned from running a micro VC in the last year
It’s been about a year since I started working on Hustle Fund with my business partner Eric Bahn. People often ask me what it’s like to start a micro VC and whether they should do one too. (Hunter Walk just wrote his perspectives here)
Here are some of my learnings from the last year.
1) It is absolutely the best job in the world for me.
I enjoy learning about new technologies and ideas – and you get to see a lot of them in this business especially in early stage investing. And I enjoy working with founders immensely. But most importantly, I love fundraising. I know – that isn’t what you thought I was going to say. (more on this later)
Much like running a product-startup, you’re your own boss, so you sometimes end up working really hard and at all hours depending on where you are in your fund life cycle. But, if it’s work you enjoy, then it doesn’t feel like work. And, there’s also a lot of flexibility, and I’ve definitely taken advantage of that. You can whimsically pick the most powdery day of the winter and go up to Tahoe to ski. Or go to the beach or lake mid week in the summer and no one will be there. It’s great.
2) Starting a micro VC is just like starting a product company. Except harder.
Probably 10x harder. If you go in knowing that with eyes-wide-open, then it’s totally fine, but most people don’t do enough homework before deciding to start their funds. I would talk with at least 10 micro VCs before deciding to do this.
3) In particular, there is no money in micro VC!
Hah - this seems ironic, but I’ll explain.
Most people think VCs have a lot of money. That’s if you work for an existing large established VC. But if you are starting a VC, this is definitely not true. I’ll break this down across a few points, but the gist is that you have to be willing to make no money for 5-10 years.
If you are not in a solid financial situation to do that, this business can be terrible for your personal life.
3b) Micro VC’s have no budgets.
This is surprising to a lot of people. Even if you have say, a $10m fund, most of that money needs to be used for investing – not for your livelihood or for other things.
In fact, the standard annual budget that VC funds have is 2% of the fund size for the life of the fund (typically 10 years). If your fund is say $10m, then that means you have a yearly budget of $200k. To be clear, this isn’t your salary – this is your budget to run your company. Your salary does come from this number, but you also need to cover salaries of everyone else on your team (if there are others on your team). And, if you travel, those costs come from this number too. If you have an office, that cost fits in here too. Health care and benefits also fit under this. Marketing – if you have t-shirts / watches / swag, parties – all of this fits under this budget. There are also fund ops costs that need to be factored into this number too. As it would turn out when you factor in all these costs, $200k actually doesn’t go far. To give you some perspective, my salary today is less than what I made at my first job out of college…in 2004.
You need to be willing to bootstrap for about 5-10 years. In contrast to building a product company, where most people bootstrap for maybe 2-3 years and then either raise some money or build off of profits or throw in the towel, when you sign up to do your own VC, you are committed for 10 years (the standard life of a fund). You can’t throw in the towel. And if your fund does well – i.e. your companies either raise more money or they grow their revenues a lot – you also don’t make more money, because your salary is based on a percentage of your fund size. So your salary (or lack of salary) is stuck for years – until you raise your next fund when you will have new budget from that fund.
Some Micro VCs write into their legal docs that they will frontload all of their budget in the first few years. Under this model, instead of taking say a $200k budget per year for 10 years, some funds will do something like frontload the budget – say $400k per year for 5 years. This can help increase your budget, though there are still fund ops costs every year for 10 years, so I’m not sure how these funds end up paying for those costs in years 6-10 if they are taking the full budget up front. This is not something we do at Hustle Fund.
Other micro VCs will try to make money in other ways by selling event tickets or whatnot. In many cases, depending on how your legal docs are written, consulting is discouraged. So it actually is very hard to bootstrap a micro VC, because on one hand, you get virtually no salary but are also mostly prohibited from making money outside of your work.
3c) You also will make General Partner contributions to your fund.
At most funds, you will also invest in your fund as well. This allows you to align with your investors and have skin in the game, and this is standard practice. In many cases, fund managers invest 1-5% of the fund size. So if you have a $10m fund, you’d be expected to invest at least $100k to the fund.
So, not only are you not making money on salary, you are also expected to contribute your own money to the fund.
There are some funds that don’t write this requirement into their legal docs, but it’s something that a number of would-be investors always ask about (in my experience). They want you as a fund manager to be incentivized to make good investments, because you are staking your own cash too. And this makes sense.
3d) Sometimes you need to loan money to your fund.
There have been several cases over the course of the last year, where either Eric or myself have had to loan Hustle Fund money interest-free to do a deal that needed to be done now (before we had the fund fully together).
One thing that is different about raising money for a fund (vs a product-company) is that when investors sign their commitment, they don’t actually send you the money right away. So, let’s say we raise $10m, we don’t actually have the $10m sitting around in a bank account. This surprises a lot of people – VCs don’t actually have cash on hand!
The way investors invest in a fund is they sign a paper committing to invest in the fund. And then later, when the fund needs money, the fund does a capital call. Typically, capital calls are done over the course of 3 years. So, if let’s say an investor commits to investing $300k into a fund, then on average, that fund will call 1/3 of the money each year over the course of 3 years. In this case, that would be roughly a $100k investment each year from this individual. The capital calls are not done on a perfectly regular cadence, because sometimes a fund will need money sooner than later. But most funds try as best as they can to do regular capital calls.
But, this also means that there’s a lot of strategy and thinking that needs to go into capital calls. For example, when you’re first starting out to raise money and have very little money committed – say $1m, it can be tempting to call 50% of the money right away to start investing $500k into a couple of deals. However, as you continue to raise, subsequent investors, will be required to catch up to that 50% called amount. And let’s say you round up another $6m in capital, this means that all of a sudden you have $3m that you’re automatically calling to catch up to the proportionate amount that the first set of investors contributed. And if you’re writing small checks out of your fund, much of that $3m will then just sit around in your bank account not earning interest and will negatively affect your rate of return. So instead of doing a capital call, loaning your fund money is a way to ensure that you don’t have capital just sitting around in your bank counting against your rate of return.
There are bank loans you can get once you are fully closed and up and running, but very few banks will loan you money in the very beginning when you have raised nothing - hah.
3e) And even if your fund does well, you still make very little money at the end of 10 years!
First, most VC funds are failures. In fact, much like startups, I’ve heard that 9 in 10 VCs will not even get to 1x returns!
But, if you happen to be in the lucky 10%, there’s even a range here. The “gold standard” for profitable VCs is a “3x return” benchmark. If you’re above it, you’re considered excellent. And this is very hard to do. Just getting into the profitable category is an accomplishment in itself. But, let’s suppose for a moment that your fund is excellent (because we all believe that our funds are excellent). And let’s say that we return 5x on our fund.
On a $10m fund, a 5x fund return means the fund will return $50m. Using a standard 20% carry formula, and after returning most of the gains to the fund’s investors, it means that the team will receive $8m. If you have 2 managing partners, that’s $4m per person – but 10 years later. Considering that you’ll make no salary for much of that time, there are many other professional / tech / established VC jobs at big Sand Hill firms that will make you more money or the same amount of money on salary alone (not including benefits or stock) with greater certainty. You don’t have to be a 90%+ performer as a Director of Product at Google to accomplish the same outcome as an exceptional micro VC manager. Think about that – you risk so much, much like a startup, but your upside is equivalent to working a steady job at Google for 10 years!
For all of these reasons, this is why microfund managers who are able to raise more money on subsequent funds end up doing so, because for the same amount of work and risk, you’d much rather be paid more in salary and in carried interest later.
4) You should love fundraising.
I think most people think that as a VC you spend most of your time looking at deals. The breakdown of a given week for me is something like:
50% fundraising-related (preparation of materials / meeting potential future investors / networking / etc)
20% marketing-related (content / speaking / etc)
5% ops (legal / audit / accounting / deal docs / etc)
15% looking at deals (talking w/ co-investors & referrers / emailing with founders / looking at decks / talking with founders)
10% working with portfolio companies
Of course, it varies a bit depending on if you’re at the beginning of a raise or if you have closed your fund. But, the point is, you will spend a solid chunk of your time as a micro VC on fundraising activities. Even if your fund is closed and you don’t have a deck to pitch, you are always in fundraise-mode.
If you have never fundraised for anything before, you will probably think that this process is horrible. Having raised money before for my startup and having coached a lot founders on fundraising over the last few years, I’ve grown to love it. And part of that is just lots of practice – the more you practice, the better you get, the more you like something.
5) Fundraising for a micro vc is exactly like fundraising as a product-startup. Except more involved.
Prior to raising a fund, it never occurred to me where fund managers raise their funds. That was just not something I had thought about before. For the big Sand Hill VCs, most of them raise money from institutionals. These are retirement / pension funds at goverment entities. Or endowments at universities. Etc. But as you can imagine, these entities are pretty conservative. And rightly so, the pension check that granny is counting on for her retirement shouldn’t be frivalously thrown away on a fund that invests in virtual hippos recorded on some blockchain.
So as a first time manager, often it can be difficult to convince these types of institutional funds to invest. It can be done if you have a strong brand already. But even if you are an experienced angel investor or worked at a well-known VC fund, you’re still starting a new fund with a new brand, and there are still questions about whether you can repeat your past success on this new brand.
This means that much like product-startups, you end up raising from individuals, family offices, and corporates primarily. But much like with raising money from angels and corporates for a product-startup, angels and corporates don’t have website announcing that they are funding vc funds. You have to hunt for these folks. Often these “angels” whom you can access are folks you know or folks who are 2-3 degrees away from you whom you don’t know yet (see my post on raising from friends and family).
And much like a product-startup, the check sizes are going to be smaller if they are from individuals (unless you know lots of very very wealthy individuals). When we first started fund 1, our minimum check size was $25k – much like the minimum investment amount for a typical product-startup. Except that we were raising tens of millions of dollars not $1m. So, $25k doesn’t go far on say a $10m fund.
This means you need to be doing lots of meetings. And this takes time. The average time for a microfund manager to raise a fund is ~2 years. We felt fortunate and incredibly thankful to our investors to be able to raise our fund in < 1 year. But, when you think about it, that’s still months of actively fundraising. (see point #4)
6) And you have a limited number of investors you can accept.
Per SEC rules, you can only accept 99 accredited investors into your fund. This means that if you want to raise a $10m fund, you need the average check size to be above $100k.
When product-startups set a minimum check size, it’s usually arbitrary. If you’re raising $1m for your product-startup, it won’t hurt you to take some investors at $1k or $5k checks here and there, especially if they are value-add. With a fund, every slot counts.
So when we started with $25k as a minimum check size for some friends, we knew we needed to quickly raise that bar in order to raise a significant enough fund and still maintain 99 investors. We ended up having to turn away a lot of great value-add would-be investors who could not do a higher investment. I would have absolutely loved to have brought in more investors if I didn’t have this restriction.
In other words, you cannot just accept $5k here and there from friends and claw your way to momentum.
To get around this, some funds set up a “1b” fund. E.g. Hustle Fund 1a and Hustle Fund 1b and split startup investments equally between the two. That would be one way to get bring in more investors, but the costs of this setup start to go up, so we decided not to do this.
7) Ok, so there’s no money. You also cannot change the world on fund 1.
If you can get past all of the above, and you’re still “yay yay yay – I want a life of making no money and want to fundraise all day and night for whatever cause I am trying to support,” the last piece is that you should know that you cannot change the world overnight.
I know so many aspiring micro VCs who go into this, because they want to fund more women or minorities or geographies or some vertical that is underfunded. And I think those are all awesome worthy causes. And me too – the reason I’m doing this is that I don’t believe the early stage fundraising landscape is a meritocracy, and I want the future of funding to be much more about speed of execution rather than about what you look like or how you talk.
But you absolutely need to go into this with a 20-30 year plan. And the reason is that you’re a small little microfund with say $5m, you won’t be able to change the numbers in any of these demographics, because impact happens at the late stages when VCs pour tens of millions of dollars into companies – not $100k here and there. What does effect change is having lots of money under management. And that happens by knocking fund 1 out of the park. And then fund 2. And then fund 3. And growing your fund each step of the way. And growing your believers who start to hop onboard your strategy – not only your investor base but other VCs. And that is a 20+ year plan.
Moreover, you need to be contrarian to have a good fund. But at the same time, you cannot be too contrarian either on fund 1, because you need to work with other VCs in the ecosystem. You need your founders to get downstream capital. So to a good extent, I do care a lot about what downstream investors think and how they think about things. You can only start to be very contrarian once you have more money under management (i.e. have proven out the last couple of funds) and follow on into your companies yourself.
So in short, you will not make any money on fund 1. You might need to loan money to your fund. You will need to have money to invest into your fund. You will constantly be selling your fund as an awesome investment opportunity for this fund and the next fund and the fund after that, etc… And you will not change the world on fund 1. But, if you still love all of this and go in with eyes-wide-open on all of these things, and if you believe you want to do this for the next 20-30 years, then I would highly encourage you to go for it. I think it is the best job in the world.
Fundraising is a nebulous process that I aim to make more transparent. To learn more secrets and tips, subscribe to my newsletter.
