The Mistake Most First Time VC Fund Managers Make

In VC funds, there are two target customer groups for the business, startup founders and limited partners (LPs). Most first time VC fund managers (VC founders), including myself, tend to focus on the first target group. That’s why, in my opinion, most of them fail to raise a second fund.

As a first time fund manager, you would usually have a small fund ($5m-$25m). Conventional wisdom suggests that you invest smaller tickets in more seed stage startups (20–50 pre-seed/seed companies). This way you can diversify more, reduce your risk, and increase your chances of some return on the long run, while slowly developing your VC firm and your investment thesis. It sounds like a good evolutionary process where you learn by doing. It’s also much easier to access such deals as founders are more desperate to get started and there is less competition on those early stage deals.

Every new VC fund manager I meet wants to lead or be the only investor who writes the first check in pre-seed startups! They want to prove that they can spot good companies as early as possible. They also go crazy about building the brand through social media, blogging, and speaking at conferences to connect with founders.

But, there are a few issues with this suggestion. First, you don’t have the luxury of time! You’re fund is small, the fees won’t last you many years to prove that your selection criteria is good enough, and when time comes to raise your second fund, your portfolio won’t be in a position to impress LPs yet, even if you’ve selected the best seed companies out there. Second, by focusing on seed stage startups, you’re inherently accepting higher levels of risk knowing that most of new startups don’t make it to the next stage. There are team risks, technology risks, market risks, competition risks, funding risks, economic risks, and legal and regulatory risks. Third, if you think about it from an LP point of view, you would add even more risks related to the team running the fund. Fourth, being out there and meeting lots of founders might actually harm your brand as you might look like you’re overpromising.

I think seed stage investing is a luxury that only big funds (and angel investors) can afford, but not small new funds.

As a first time fund manager with a small fund, the target customer group you should focus on is LPs not founders. Contrary to the conventional wisdom, I think you should invest bigger tickets in less later stage companies (5–10 Series B/C companies). This will dramatically reduce your risk, and speed up the process of building an impressive portfolio, that will enable you to raise a second fund faster.

Whenever I mention this, the first reply I get is: “But founders of good later stage companies go to well established firms, we can’t get access to such deals!”. Well, that’s an access problem, and there are a few solutions for it.

First, forget about being a lead investor, you can’t get control now anyway. So always be a follow investor until you have a big fund.

Second, focus on building value-based relationships with top VC firms to include you in their deals. Your value could be through market research, or specific domain expertise, or connections to a minority group or an emerging market. In other words, focus on helping those big VC firms instead of competing with them. They will include you in their deals as a value-add follow investor once they know you can help. In other cases, if you can, bring them deal flow from domains you know best based on your operational background.

Third, connecting with more VCs will open up opportunities for you to buy portions of their holdings in secondary transactions when a fund term ends, or when a portfolio company runs a tender offer to provide liquidity to its employees.

With this deal access strategy, you can afford to spend more time building your brand among LPs (as opposed to spending all your time building your brand among founders). There are multiple sources of investment data such as CrunchBase or CB Insights, use that to continuously post new research on VC funds performance, or case studies on funds, or new investment trends. Then meet new LPs every week, and use your research as an entry point, i.e., to share with them your findings and initiate the relationship. At the end of the day, not every meeting with an LP should be for fundraising, connecting with institutional LPs takes years of relationship building.

In summary, I think first time VC fund managers with small funds need to think more late stage via other VC firms (as follow investors) and focus on LPs relationships, as opposed to, thinking seed stage and focusing on founders relationships.


The Mistake Most First Time VC Fund Managers Make was originally published in VCpreneur on Medium, where people are continuing the conversation by highlighting and responding to this story.

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The founder of a healthcare venture fund that just raised $200 million shares why she wants to back founders that are building businesses for their communities

Summary List PlacementOne of digital health’s only early-stage venture firms just raised a fresh tranche of funding to help the youngest startups get off the ground during a pivotal year for the industry.
Define Ventures raised $200 million for its latest fund, the second since it was founded by ex-Kleiner Perkins investor Lynne Chou O’Keefe in 2018.
The early-stage firm will continue making new investments in companies in the incubation stage all the way up to Series B, Chou O’Keefe told Business Insider.
The new fund’s timing, coming after a record-setting year of private investment in healthcare startups, was purely coincidental and on track with the typical two-year fundraising cycle at most firms, she said.
“We’ve had well-timed investment cycles,” Chou O’Keefe said “But the activity has increased, overall, post-COVID.”
Read more: A former Kleiner Perkins investor is staking out the future of digital health. Here’s why she just made an early bet on an in-home care startup founded by a former Uber exec.
Define wants to back early startups rebuilding the healthcare system with patients at its center
Chou O’Keefe said she anticipated keeping up the pace in 2021, writing more checks to companies she believes are reimagining what it’s like to be a healthcare patient in the United States. In Define’s first $87 million fund, she backed a wide range of digital health startups, including LGBTQIA+ primary care startup Folx and in-home care provider MedArrive.
She said to expect more of the same coming from Fund II, with consumer-focused healthcare startups taking center stage over other companies that want to sell services to hospitals or insurance companies. The firm’s thesis formed around backing companies that use technology to reimagine the patient’s experience of healthcare was successful enough in Fund I to earn a vote of confidence in Fund II, Chou O’Keefe said.
“We haven’t seen our strategy shifted, it’s more that the time to market has really shortened,” Chou O’Keefe said. 
In practice, the consumerization of healthcare Chou O’Keefe wants to back varies widely. It can look like Dawnlight, a startup that makes remote monitoring products that track fall risks, among other specialties. It can also look like Lightship, a startup that runs decentralized clinical trials that are easy for participants and researchers to use. All these startups, however, share the unique challenge of marketing to regular patients instead of working directly with hospitals, doctors, or insurance companies.
“The make-or-break of digital health is the commercial side of the business,” Chou O’Keefe said. “That’s something that is so critical, and when I started Define the lack of sector-focused early-stage players was a window of opportunity for us because these entrepreneurs need help to build. It takes a village to change healthcare for all of us.”
Chou O’Keefe is betting that founders want to build for their own communities
Chou O’Keefe will write checks from $1 million all the way up to $15 million, depending on the company’s needs. As a former Livongo board member and current Hims board member, she said Define can lead funding rounds that require the active board support, but ultimately leaves that decision to the entrepreneur. 
“Entrepreneurs recognize the oil from water here,” Chou O’Keefe said. “There are people that can partner with you and build these companies with you, but the lessons learned from tech don’t apply in the healthcare space.”
Her investment strategy is in part a bet on authentic founders, she said.
She is particularly interested in supporting the entrepreneurs that are building solutions for their own communities because that perspective can be a differentiating factor that contributes to a company’s success.
Of Define’s 12 portfolio companies, four are founded and led by women, one of the many communities Chou O’Keefe feels has been left out of high-level healthcare business decisions in the past.
“It’s important we have women founders and CEOs in this space because we make the decisions, and it’s really the right business decision as well,” Chou O’Keefe said.SEE ALSO: The 26 billion-dollar startups to watch that are revolutionizing healthcare in 2021
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