What Makes a “Great” VC? Decoding Greatness in Venture Capital: A Comprehensive Guide… of What VCs Think Other VCs Should Be Doing… Part 1
A famous playwright once wrote ‘Some are born great, some achieve greatness and some have greatness thrust upon them.’
What is very clear, in my opinion, is that all Venture Capitalists (VCs) rely on the greatness of founders to truly be successful. However, data (do check out this link) shows that some funds perform better than others, which does suggest that some VCs may know what they are doing more than others.
Whilst many VCs would likely answer “what makes a great VC” via a rumination of complex sentences (including myself ;)), I think it is first important to define the word “great”.
Great, like many adjectives, is in the eye of the beholder, and what makes it even more challenging within this specific context, is the fact that perhaps the most quantifiable way to define a great VC is:
A VC that has invested in deals that end up exiting well (i.e. returns significant funds back to Limited Partners and into their own pocket)
but this outcome can take over ten years to come into fruititon.
In the meantime (as very few VCs have that many working years on their shoulders), I have been told that what a VC must do well and is expected of them from the ecosystem, is five tasks. All of these tasks contribute towards the “greatness” title. For each task, I will endeavour to give context and/or examples.
However, before I do, as a prelude to Part 2, I would encourage you to challenge the value of each and everyone of these tasks and to whom it benefits the most….
1. Raise a fund (and then raise another)
This is a bit of a chicken and egg task. As without a track record, it is very challenging to raise funds from Limited Partners (LPs). Pair that with the fact that most LPs require General Partners (GP) to put in their own capital, means that to raise your own fund, you have to have a lot of your own money (erhem perhaps a long lost wealthy aunt?), or strike a deal with a bank whereby your salary pays back your loan that you have invested into the fund. Either way, it is challenging and inaccessible to most. Check Warner, partner at Ada Ventures wrote a fantastic blog series on this arduous task, Associated Podcast also did a podcast Series on “How to raise your own fund” that shared light on this challenge.
Interesting fact: According to a PitchBook analysis of investment teams who raised a debut venture fund between 2007 and 2013, those with both operational and investment experience were more likely to raise a second fund, which they did 66% of the time. By contrast, teams with no experience as startup founders or investors raised sophomore vehicles 58% of the time. Key learning here, raising your first fund certainly does not guarantee you a second.
Nonetheless, to get out of the starting gates, you have to have capital to deploy. The training slopes as a junior VC is helping your portfolio companies raise money, but I will cover this topic briefly in another section.
2. Source excellent start ups
Defining what “excellent” is, is a whole series of blog posts in of itself but here are several strategies that VCs adopt to source deals:
Network: One of the best and worst components of VC is that funds often share deals with other funds. This leads to an unusual blend of collaboration and competition. Therefore, exchanging deals becomes a flirtatious card game, where VCs meticulously choose who to tell about which deals, when. Relying on a network of other VCs, allows an individual (founders also take note) to also leverage bias, VCs are one of the worst industries when it comes to FOMO. If you have a skillset of convincing others to show their cards and for them to want to participate in your deals – then in both cases, in many peoples’ eyes, those deals might be defined as ‘Excellent’.
Thesis driven investing: Ironically, not a huge number of investors adopt this strategy, as it is in some ways more work than chasing after the next “big thing” (erhem electric scooters, “Quick Commerce”). This is where a VC dives into the topic head first to understand the nuances of the industry, what solutions are already out there, what are the problems they are facing, how much is that industry willing to pay for that solution – rather than relying on founders telling them the answers to these questions, a VC has the answer themselves and a clear view of what they are looking for. Then it is a search to find the founder who is building or has built it, often by speaking to industry leaders.
Data-driven sourcing: There are now billions of data points online, which could be used with the power of AI to identify start ups. The earlier the business the harder it is to determine its success, nonetheless, funds such as Quantum Light and EQT power their proprietary search engine. There are also off the shelf tools that you can purchase such as Spectre or Landscape. Searching the wide web certainly can help you uncover promising start ups, the secret is figuring out what parameters to look for before undertaking the search.
Surround yourself with awesomeness: People are, in many ways, the currency that Venture Capital run’s off. It is not a coincidence that many say ‘to surround yourself with people more intelligent than you’. Not all, but many, of the most intelligent people I know like to challenge the status quo, a characteristic that often makes for an ideal founder profile. Investing in your friend’s businesses has one big advantage, your due diligence goes back many years (!), however, having a degree of separation can be helpful if things ever go South….
Open mindedness: Luck flows all around us, it is up to us to ride its wave – meaning (!) – making the first move. I have had the good fortune of meeting many interesting people on planes, buses, queues, the list goes on. The next phenomenal talent you meet may not be in the most obvious place and being open to meeting new people in non-obvious settings will guarantee you to build some interesting relationships. As many people say with VC – it is a job that is very easy to never ‘turn off’.
3. Winning deals
Winning allocation in a hotly contested deal is no mean feat. Much like 2nd year university housing (if you know, you know), a strange phenomenon happens when VCs hear the sentence: “we have a term sheet” - they enter into a state of frenzy. Valuation starts to skyrocket and investors will do anything to win over the founder.
I have heard stories like investors buying concert tickets to the founder’s favourite band, showing up to their offices unannounced with flowers and even cold calling.
Although these examples are rather extreme (!), there is a real art to building a strong relationship with a founder to the point where they pick you over the other offers available to them. Thus, reputation is everything in the VC ecosystem. The best pieces of advice I have gathered over the years is:
A) to help everyone the best you can
B) be open about what you know and what you don’t know
C) learn as much as you can
D) do not jeopardise the reputation of others
E) be early
4. Supporting portfolio
Many founders I have spoken too see most VCs as a means to an end. A rather harsh description I was once given was that VCs “are self-proclaimed surgeons who lack the knowledge of even performing the simplest of surgeries…”
Especially generalist VCs have the challenging task of having to have a breadth of knowledge, but that results in having challenges with depth of knowledge in so many technological areas. Furthermore, many VCs lack the capability to code so looking under the hood often becomes an impossible task. A prime example of this is the infamous “Bad Blood” case whereby most investors lacked the scientific acumen to understand that what Holmes was trying to achieve, was close to impossible.
Nevertheless, capital can go a long way in giving founders time to learn, rectify mistakes and gather a super star team around them. There are also many other ways to support founders in order for them to gain the upper hand, such as:
Solving problems: Jan Miczaika from HV Capital, told Associated Podcast when discussing on whether you should accept investment from European or US VCs, that one of his portfolio founders had a challenge with a company bank account freeze situ. Turns out that one of Jan’s colleagues’ next-door neighbours was a senior director of the bank, a phone call later well, listen to the clip to find out…. I was once told that there is almost always one valuable introduction you can make – a good tip is to start building your own personal CRM and categorising them accordingly.
Clip of this brilliant conversation below:
Talent network: A superstar team can go a long way; VCs are in the privileged position of having met and be connected to an array of exceptional talent or great recruiters. A16z’s Ben Horowitz puts a lot of emphasis on this that he has an entire team dedicated to helping founders identify key hires. If you take pride in the friends you gather around you, there is a high likelihood you already have access to a bountiful talent pool – joining the dots is a powerful super-power.
Opening doors: Not all money is equal. Founders often need to raise many subsequent rounds to realise their vision for their company. According to Dealroom, companies raising a seed round from top investors are significantly more likely to raise and to do so faster. There could be many factors at play here, but it is a known fact that tier one investors talk and have often built a strong relationship with one another. Thus, as a new investor, building relationships with top tier funds is exceptionally powerful, this process takes time and energy but (could) increase the success of your portfolio exponentially.
Ironically, none of the above value add services requires VCs to understand what the business does, but some founders have told me that these kinds of contributions can still significantly move the needle for them in determining the success of the company.
5. The art of adding and exiting
As mentioned briefly in the introduction, there are two scenarios where a VC might finally be able to don the label of a “great investor”. The first is rather half-baked – that the company has reached a big valuation (ideally >$1bn plus) within the private market, but some may argue that the true determinant of success is when a company exits at a much higher multiple than what was originally paid and the returns land in the bank.
Deciding whether to commit additional reserves to maintain dilution (see our past article “Fake Gods”) as well as when to exit a company at the right time, at the highest price and with full alignment from all investors and the founding team, is a difficult for just the founding team to accomplish alone. VCs can play a part by advising a founder on this journey, helping gain board consensus and potentially introducing them to a viable buyer or in some cases be the buyer.
Each task could have a standalone blog post diving many more layers deeper into what has been covered, but as a consortium, many VCs believe that they equate to the desired North Star reputation of a “great VC”. I would like to emphasise that I believe this to be the idealist version of the definition of what a “great VC” is and does - stay tuned for Part 2 a healthy dose of realism……