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With yesterday’s announcement that early-stage VC Greycroft has raised a $200 million growth fund, this type of fund has officially become a trend. But before we dig into the dynamics of it, let’s pay homage to the originator of this concept, Union Square Ventures.
In January 2011, USV raised what I believe was the first “opportunity fund.” Prior to this, plenty of VC firms invested across the early stage to late stage spectrum from the same fund (e.g. Battery, General Catalyst, Sequoia, Greylock, Bessemer). Others had separate early stage funds and late stage funds, often with separate teams and economics (e.g. Redpoint, DFJ, North Bridge) typically aimed at different opportunities. But the USV Opportunity Fund was the first time, at least in the post 2001-Internet bubble cycle (or last decade, if you want to put it that way) where an early stage firm created a separate fund to invest in late stage rounds of their existing early-stage portfolio companies. In USV’s case, Fred Wilson explains the strategy extremely clearly in the post The Opportunity Fund.
Greycroft is the latest firm to raise this type of fund. In the last week I’ve talked to two other early stage VC firms who are raising similar opportunity funds. In one case they referred to it as a growth fund. In the other case they referred to it as an opportunity fund.
In the fall of 2013, we raised a similar type of fund called Foundry Group Select. It was a $225 million fund, just like our other three $225 million funds raised in 2007, 2010, and 2013. But we called it “Select” instead of “Growth” or “Opportunity” for a specific reason – we only use it to invest in existing portfolio companies of ours.
USV has done a magnificent job of investing in later stage rounds of their existing portfolio companies as well as later stage rounds of companies that fit tightly within their investment thesis. We decided to drop the second half of that strategy as we didn’t want to spend time being late stage investors. It’s not natural for us as an entry point and we didn’t want to add anyone to our team since keeping our team size exactly the same is a deeply held belief of ours.
The decision to raise this fund came out of a combination of desire and frustration. We have a well-defined fund strategy, based on a constant size of each of our funds. Our goal is to make about 30 investments in each fund (2007 has 28, 2010 had 31) that range between $5m and $15m over the life of the company. Part of this strategy is that we are syndication agnostic – we are happy to go it alone through two or three rounds of a company if we have conviction about what they are doing. We are equally happy to syndicate with one or two other VC firms. Either way, while we focus on being capital efficient (we’d rather not overfund the companies we are involved in early), we are interested in buying as much ownership as we can at the early stages.
As a result, when a company begins to accelerate dramatically, we weren’t in a position to contribute meaningfully to the later stage rounds since we’d likely already have something in the $10m to $15m range invested. That’s the desire part of the equation – we knew we could make money off a later stage investment, but when we were talking about investing an incremental $1m or $2m it didn’t really matter much.
The frustration part was more vexing to us. In a number of our successful companies, we saw a long line of financial investors lining up to follow. None of them would engage as a lead, but all want to participate when a round came together. If a company was raising $30m, we’d have $50m+ of “followers” waiting to take whatever was left. We didn’t find that particularly helpful.
So we raised Foundry Group Select. We explicitly limited it to only companies we were already investors in and on the boards of. As a result, it is literally zero incremental work for us since we are already deeply involved in the companies we are investing in. This led us to an interesting decision – since we recycle 100% of our management fee, why would we charge a management fee on this fund if we are doing no incremental work? The conclusion was easy – we don’t charge a management fee. We only make money when the investments make money, resulting in very tight alignment with our LPs.
To date, we’ve invested from Foundry Group Select in Fitbit, Sympoz, Return Path, Gnip (acquired by Twitter), and Orbotix. It’s been a powerful addition to our strategy without creating any extra overhead on us.
I’ll end where I started – by paying homage to our friends at Union Square Ventures. They’ve led the way on many elements of early-stage investing post-Internet bubble, dating back to 2004 when Fred and Brad raised the first USV fund. As the “opportunity fund” becomes a trend, they’ve once again created something that, in hindsight, looks brilliant.
I heard a fascinating one-liner the other day that I had knee jerk negative reaction to but when I thought about it more thought was deeply insightful, especially in the context of big established companies vs. new entrepreneurial companies.
A CEO of a very large, successful company said “execution is an order of magnitude easier than opportunity.” In the context of young startups, I often feel exactly the opposite. Opportunity is everywhere, but execution in a bitch.
But then I thought about this a little. For a big company that dominates a market, it’s totally focused on execution. The company is built for execution and, assuming it is built well, just cranks things out. What it cranks out might be inspiring, or it might not be, but it’ll keep cranking things out.
For these companies, finding the new opportunity is really difficult. The company is tuned to defend its turf, not go find new turf. Execution is all about defending market position, maximizing profit, expanding market share in existing markets, and allocating resources. In a few extraordinary cases, this activity is massively inspired, usually around companies that love their products (Apple) or their customers (Virgin). So – for most of these companies, “execution” is easy relative to finding the new opportunities. And many of these large companies don’t focus on finding the next opportunity, or expanding their existing opportunity, until their business hits major headwinds, is in decline, or is massively disrupted. I give you Borders, B&N, and Blockbuster as examples here – awesome at execution until what they did became irrelevant and then it was too late for them to do anything about it (other than maybe B&N, who might pull off their transition.)
In contrast, startups are totally focused on the new opportunity. Assuming they find it, and it’s a big one, execution becomes the main challenge in front of them. Their activity is all about scaling up the organization, hiring people like crazy, building a culture of shipping great product consistently, reacting effectively to early customer feedback, and continuing to evolve their products to meet the new massive opportunity they are going after.
From the eyes of a big company CEO, finding the opportunity is hard. From the eyes of a startup CEO, the opportunity is everything – execution is hard.
My insight is simple: “context matters immensely.” As young companies grow rapidly, they have to focus on becoming execution machines and recognize that at some point they’ll start struggling with identifying the next evolution of their opportunity space. Assuming the opportunity they are going after is massive, this won’t matter for a while. But the execution dynamics will. And when you find yourself executing well, dominating your market segment, and growing quickly, you’ve got to make sure you keep focusing on expanding the opportunity, especially since that’s going to get harder as you get bigger.