Monday, September 9, 2013

Introducing the Chicago Area Limited Partners Association (CALPA)

I am thrilled to announce the founding of the Chicago Area Limited Partners Association (CALPA), the first and only organization founded by Chicago's private equity limited partners, for Chicago's private equity limited partners.

The goal in founding CALPA is to increase the number of like-minded, private equity limited partners who are eager to share and discuss best practices, topics and trends amongst each other in an intimate and casual setting.  We are looking to Chicago's endowment and foundation, family office, insurance company, wealth management, public/private pension, investment consulting and fund-of-funds communities to join us a members of CALPA.

Chicago always gets ribbed for being the third coast or the second city, but with a litany of thought-leading and large limited partners in the greater Chicago area, why can't we be private equity's first city?  CALPA will hope to serve as that meeting ground for Chicago's limited partners to network, share ideas, learn and collaborate, while also having some fun!

Our plan is to have three free luncheons a year where limited partners can hear from industry-leading GPs, fellow limited partners and service providers about best practices, topics and trends affecting all of our portfolios. With no obligation to join and no cost to participate, we hope to have truly engaging topics of conversation that go well beyond the canned conference panel or annual meeting spin.  Moreover, we hope that getting a group of like-minded limited partners together will foster an environment of collaboration and mind share with members learning from each other, sharing ideas and forming friendships over the long term. 

Our aspirations are high, but our goal is simple: offer a free lunch with great speakers (not hawking their fund) and hope that the network effect of CALPA extends beyond itself.  

Our first event will be held in mid November (TBA).  Lunch will be served followed by a lively panel discussion (TBA). Stay tuned for additional details on our first event!

Lastly, I'd like to profusely thank the wonderful and forward-thinking people at Northern Trust, the John D. and Catherine T. MacArthur Foundation, Northwestern University, Kirkland & Ellis LLP and the Illinois Venture Capital Association (IVCA) for serving as co-founders of this exciting organization. We hope that you too will join us for the first event in November!

If you're a Chicago area limited partner that invests in private equity and would like more information on CALPA or would like to become a member and attend our first event, please do not hesitate to email me at  

Monday, August 12, 2013

What To Do With My Unfunded LP Commitment Before Capital Calls?

I got an interesting question the other day from a client about what to do with the unfunded portion of his LP commitment.  It was the first time I got the question from an LP but have actually been thinking about it myself quite a bit.  Of the LP capital commitments I have to date, the unfunded portion is sitting all in cash. Over the past several quarters I've realized, that the time value of money on that cash just sitting with my bank is really unexciting given how well the public markets are performing of late.  So I asked myself the same question the LP did of me, what should I do with the unfunded cash I have set aside?  Being a naturally conservative person, I've always thought I should hold everything in cash so that I never have capital call timing issues.  That may be the conservative reformed lawyer in me or the worry wart, but I think a lot of people simply keep their unfunded commitments in cash.  With a fund-of-funds structure, its capital calls are much more predictable and easier to manage on an individual LP looking to commit roughly 15-20% a year of the LP's capital commitment during the first 3-4 years with it tapering in later years.  

But, do I need 100% of the unfunded commitment amount in cash?  I probably don't and probably shouldn't because a 0.01% interest rate from J.P. Morgan isn't beating any PME (including inflation)!  As such, I've made a tactical decision to reserve one year's forecasted capital call needs in a money market fund and then have the rest of the unfunded/unreserved capital commitment be invested in mutual funds without early redemption penalties, just to be extra safe.  

No one talks about the real return on your money in private equity if you commit $100,000 in Year 1 and then only have $50,000 drawn by the end of Year 3 and $50,000 continues to sit in cash.  A good portfolio manager should be thinking about what to do with your entire capital commitment, both unfunded and funded.  Obviously, an adviser should be helping you pick good funds (the funded piece) and then be helping you maximize your all-in net return by eking out a few hundred basis points of alpha by actively (or passively using mutual fund indexes) managing your unfunded commitment.  The goal in private equity should be to outperform the public markets by 300-500 basis points, and the all-in net performance of the unfunded commitment should be part of this calculation as well.  Obviously, it will vary from LP to LP with no two LPs having the same asset allocation of their unfunded commitment, but I don't think it's a topic that is often discussed and I'm glad I woke up and made a change which should hopefully allow me to eek out a few extra basis points of alpha with the clarity of mind that I'll always have cash to meet capital calls. 

Curious what others think though and welcome feedback/advice!

Wednesday, August 7, 2013

What Is Growth Equity?

Today, Cambridge Associates came out with benchmarks for U.S. growth equity funds, which they acknowledge has a murky definition somewhere between venture and buyout.  So what is growth equity then?  Everyone seems to love it because it's like venture in that you should be able to get a venture-like 3-5x return multiple but also like buyout in that growth equity managers are investing in more mature companies that have meaningful revenue (maybe profitable) and were most likely bootstrapped by their founders prior to raising institutional capital.

Summit Partners calls their growth equity strategy: "Financing that helps exceptional companies accelerate their growth.  By providing capital, strategic guidance at the board level, and operational support, growth equity investors can help companies realize their full revenue, profit and market-value potential.  Many growth equity investors will make minority investments and prefer that current managers continue running their businesses."  That sounds exactly like venture capital, right?  Invest money, add value, make money...

In having met with managers across the entire spectrum of self-proclaimed "growth equity" managers, there is a noticeable delineation between managers that blur the lines with late stage venture and managers that blur the lines with buyout.  With notable exceptions, I think growth equity managers are minority investors and are investing in growth companies with meaningful traction and little debt coverage.  

In theory, growth equity should be the dream date for private equity LPs.  If you can take the value-added board leadership and entrepreneurial operational experience of venture capitalists and combine it with the investment banking financial modeling, low loss rates and shorter duration to liquidity of the buyout space, what more can you ask for.  If you can do a 3.0x net TVPI over an 8-year investment period consistently, wouldn't you invest in that fund all day, every day?  

As late stage venture capital has become overheated and the irrational exuberance of piling into the latest and greatest tech company in the Valley subsides, we're seeing more VC firms who do later stage investing become "growth equity firms".  Moreover, we're seeing more buyout firms seeking proprietary dealflow and alpha by chasing high growth venture-backed companies.  I don't see any difference between a buyout fund doing a minority investment and calling it growth equity, or a venture fund doing a later stage deal with no previous venture money in the company, and calling it growth equity.  

What really defines growth equity is the sourcing.  If there is no proprietary deal any more in the venture ecosystem, there certainly are proprietary deals in the growth equity space.  That's why there isn't a huge ecosystem of managers and it's hard to say who does growth equity and who doesn't.  Direct outbound calling programs are the biggest differentiators for growth equity managers are the reason why firms like Summit, TA and Insight are among the very best.  

Therefore, I don't think there is such a think as a growth equity manager, but only a growth equity deal. Growth equity may be the last bastion of proprietary deals.  

Tuesday, August 6, 2013

You Are Your Fund Size

I've been spending a lot of time meeting with new boutique VC funds raising capital right now. I think there has been a fairly quick shakeout between the haves and the have-nots in the seed stage space as the early entrants have 100+ deal track records, exits (yes exits) and good performance to show LPs.  As a result, they've been able to raise the same amount of capital as their first fund(s) or raise slightly more.  

Every seed fund raising more capital for Fund II than Fund I says they are doing it because they "could have put so much more to work in their previous winners".  You don't say...! This is really the only real explanation for increasing fund size.  It's relatively unheard of for a seed fund to increase its fund size because it is adding a partner.  

If you are a seed fund and are raising $20M, you are going to have a much different strategy and portfolio construction than a $50M or $100M fund.  Moreover, if you have a $100M fund, I would find it hard to call yourself a seed fund.  More likely, you're an early stage firm that puts down call options at the seed stage and buys its ownership at the Series A.  Otherwise, how can you possibly put $100M to work over a 3-4 year investment period if you're writing $500-750k checks?  

When you put out a pitch deck, declaring your intentions to raise a $50M seed fund, make sure you understand how you're going to be able to put that amount of money to work and make sure that you're honest with yourself and your prospective investors about your ability to write larger checks.  It's easy to be a nice guy and be invited into party rounds, it's not so easy to lead/co-lead the majority of your deals and politely yet sharply build ownership and selectively squeeze out the lemmings.  

Either the collapse or evolution of seed funds today is going to come as they increase fund sizes and react to the reality of the day that party rounds are popular and you have to be a nice guy to keep getting invited to the party, but you are your fund size and can't write $250k checks out of a $65M fund. Those funds that over time will evolve to larger lifecycle venture capital funds, will likely do so by being great sourcers at the seed stage and are able to lead/co-lead A rounds and retain board seats. If you know you're not a lead investor yet and are just getting your feet wet after having left an exited startup, be honest about this and raise a small fund, so that if you get lucky or are a quick learner, those 1-2 companies will be able to return the fund off your $100-250k check. Smart small, learn quickly and grow as your experience does. Those seed funds that are intellectually honest with themselves about what they need to be and how they need to do it, based on their fund size, will evolve and are more likely to excel as the haves in the seed stage market, and potentially emerge as the next go-to Series A funds given their networks as seed investors. In ten years when these fund are close to winding down, hopefully we'll all be able to say "they are who we thought they were".  

Thursday, June 13, 2013

Shalom Israel VC 2.0

I spent last week in Israel which was fortuitous timing given Magma Venture Partners' $1.0 billion+ exit for Waze by Google. Congratulations to the guys at Magma Venture Partners for reminding all of us why LPs should be taking a hard look at Israeli VC.  In only four days, you can meet with every single fund in the country and get a pretty good perspective on the market.  A few observations follow...

First, I think that Israel is prime for a wave of big exits. It didn't really start with Waze but with Adam Fisher's Intucell acquisition in February which returned $221 million on an $8 million investment, with Bessemer as the only investor in the Company's Series A in 2011. If you haven't heard of Adam, you should, because he's arguably one of the hottest VCs in Israel and an incredibly nice guy.  Wix, the leading website development site in the world, has filed to go public and is likely going to trade at or near a $1 billion valuation.  Kudos again to Adam Fisher, as well as Michael Eisenberg at Benchmark Israel. This is going to be a massive company and it was spawned out of Israel.  I can count at least seven companies that are doing over $100M in revenue and are all going to be huge home runs for Israeli VCs and their LPs: IronSource, Outbrain,, Trusteer, Conduit, Borderfree and Matomy.  

Second, most of the VCs firms established following the Yozma program of the 1990s' $100 million initiative to seed 10 venture capital firms with $10 million a piece, are mostly gone. Most of the VC firms established in the run up to the bubble took Israeli born entrepreneurs or operators and raised a fund around them.  It's taken nearly fifteen years and two to three funds to realize that the first wave of Israeli venture capital funds didn't work out as well as expected.  A lot of this has to do with the fact that the first generation of Israeli VCs weren't venture capitalists and didn't have mentors who had been there before in what is largely an apprenticeship business.  I think this is why you constantly hear the refrain that Israeli entrepreneurs prefer not to work with Israeli VCs, or at least VCs in Israeli that think like Israeli VCs of a prior generation...  

The Israeli market has moved to a bifurcated world with a few very good local venture firms and a few U.S. firms with dedicated teams on the ground in Israel with dedicated allocations to the country.  In the next three years, I believe we're going to see only four to five domestic funds in Israel actively investing there, with the usual cast of characters from the U.S. investing in Israel with differing degrees of significance (e.g., Bessemer, Lightspeed, Battery, USVP, Accel, Canaan, Blumberg).  What Israel is in need of is a new crop of firms that are Israel-based but have all of their networks for adding value and taking businesses to market outside of Israel. There is no domestic market in Israel (save for the need for Wave's traffic congestion mapping in Tel Aviv - brutal traffic there!) and that has been one of the greatest missing links for a decade in Israel: local VCs who know how to scale businesses in the U.S. and globally.  

Because there is no domestic market in Israel, entrepreneurs have to build businesses that other people need in global markets.  I also think that Israelis have a different view on the world than American entrepreneurs, in part because they all have 3-4 years of extensive training with the Israeli Defense Force (IDF) and in part because they are very hard working, proud people.  A flight attendant on my flight to Israel told me that when you ask Israelis to form a line, they don't queue up in a vertical fashion, but rather a horizontal line with each person being first...  It's a bit tongue and cheek, but also representative I think of the Israeli culture to be outstanding. The greatest export for Israel is its citizens' intellectual property and R&D expertise.  There is a reason why Google, Microsoft, EMC, Intel, HP, Samsung, IBM, Apple, Facebook, Boston Scientific, Cisco, and countless others all have a presence in Israel.  For example, Intel has over 7,700 employees in Israel and built its first R&D center outside of the U.S. in Israel.  Intel has invested over $7.3 billion in Israel and made acquisitions of over $2 billion to date. One of the most important things about Israeli entrepreneurs is that they aren't building a bunch of apps and insignificant iterative innovation like so many "me too" entrepreneurs in the Valley.  Israel is a country of technical engineering entrepreneurs.  

The other important thing I didn't mention about why Israeli is really attractive right now, is that the companies getting started and funded in Israel (at least by the top local VCs) are not what they used to be.  Gone are the funds comprised exclusively of asset-heavy, telco, semiconductor, hardware and comm services deals.  With the global ubiquity of open source, cloud computing, freemium business models and cloud-everything, Israeli entrepreneurs are building the same companies that U.S. entrepreneurs are.  Also, little known fact, but R&D doesn't happen in Israel because the workforce is cheaper, in fact Israel is an incredibly expensive place to hire workers.  Keep in mind, everything is imported there, even the LP capital.  R&D happens in Israel for the Fortune 500 and huge companies are getting built there because Israeli entrepreneurs are incredibly talented and think globally right out of the gate.

One of the biggest hurdles that the next generation of Israeli venture capital funds will have to fix, is the problem of selling too early.  For the past decade, there haven't been that many blockbuster exits because many local VCs have been hesitant to hold for home run, fund-returning exits for fear of not being able to raise another fund and the need to put some points up on the board.  Many of those funds are dying or gone thankfully because Israel needs to and can produce VC funds that outperform the U.S. as long as these funds ride their winners.  Thanks to Alan Feld and Abe Finkelstein at Vintage Investment Partners, they're doing later stage direct secondaries and providing some liquidity for founders to help them pay off their mortgage and bunker down for multi-million and billion dollar exit outcomes.  There is virtually no mezzanine or direct secondaries market in Israel and there should be. The smart VCs who have the gravitas to invest heavily in their winners and are playing for carry and not future management fee royalties on successor funds, are the only VCs in Israel worth investing in.  

Safe is to say, Israel has been smartly overlooked for years, but it's alive and booming and prime for the next generation of young and hungry VCs to become what Israel VC should have been all along.  

Tuesday, May 21, 2013

Access + Ownership = Seed Fund Success

With the slew of small seed funds cropping up in the market in the last two years, I think that the biggest differentiation between these funds is the combination of both access to the best seed deals as well as as owning as much ownership in these companies as possible.  This sounds like an achievable and readily apparent feat, but it is rather difficult given the current investment environment.  The first seed funds to appear in the industry who figured out how to disrupt the seed stage and offer entrepreneurs something the larger life-cycle funds didn't have a recipe for (e.g., First Round, Baseline and Floodgate) had fewer barriers in getting access to the best deals and owning as much as they could in these companies because the small fund wave hadn't appeared on the horizon yet.  Access in any venture capital fund is the greatest differentiator between the haves and have nots.  At face value, anyone can tell if a fund has good access by taking a spin through an early stage VC firm's website.

This is all well and good, but unless you're investing in a very small fund ($10-30M), owning a small piece of a big winner won't return a Facebook-like multiple back to LPs.  The seed funding market continues to exist in a state of "coopetition" where seed investors rarely if ever single-hand a deal and always syndicate initial investment rounds.  This cooperation part of the market either forces seed funds to take smaller allocations in a round or companies are required to raise larger rounds to accommodate the 2-3 hands around the table.  Writing $125-250k checks out of a $40-50M fund size makes it incredibly difficult to finance a fund-returner  (even assuming reserves), unless that company returns a 100x on a $500k investment (assuming a $50M fund size).  Seed funds that move slightly up market in size are going to have to find a way to have sharper elbows at the table without pissing off their co-investor friends and sources of collaborative dealflow, while also finding opportunities to own 7-10% of these companies at inception with an expected 5% terminal ownership at exit.

This sounds easier said than done, but it will be interesting to watch the seed fund space evolve in the next 3-4 years as the top seed managers have scaled up their fund sizes, in part as recognition of this very fact.  I think the seed space is the most honest part of the market today given this "coopetition" environment, but this model largely hasn't been deployed yet as many of these top seed managers have only recently scaled their fund sizes and began to reserve more heavily.  

Wednesday, May 15, 2013

De-Bunking Spray and Pray

I had an always inspiring meeting with Dave McClure today which got me thinking about why does everyone use the phrase "spray and pray" as a bad thing.  I immediately Wiki'd "spray and pray" and got the following definition:

"Spray and pray is a derisive term for firing an automatic firearm towards an enemy in long bursts, without making an effort to line up each shot or burst of shots. This is especially prevalent amongst those without benefit of proper training."

A few observations on this.  First, I think it's important to note that if you're going to invest in any seed-stage VC fund, it's critical to be backing a manager you think is making an effort to line up each portfolio company investment.  Whether a seed fund is investing in 100 portfolio companies or 30, each company should be invested in with the same level of due diligence and passion about building a 100x company that will return the fund several times over.  There should be a distinction when rushing to criticize a seed fund with a larger portfolio because there is a big difference between un-thoughtfully investing in tens or hundreds of companies with little diligence and hoping for the next Facebook, LinkedIn or Google, and taking a rifle shot approach to making an investment in tens or hundreds of companies with that same hope.  

The second part of the definition is key as well.  Investing in a seed fund with the benefit of proper training.  Anyone with enough capital can become an angel, and there is no shortage of cashed-out entrepreneurs seeking to raise a "micro vc" fund (see earlier post on why I loathe the term "Micro VC").  However, there is a huge difference between an angel and a venture capitalist.  That key difference is simply managing other peoples' money (OPM).  

I'm trying not to make this a defense of 500 Startups or Dave, but rather simply want to make the distinction between a VC spending OPM wildly by investing a huge portfolio and hoping that the law of large numbers and the passage of time will shake out a blockbuster over time.  After all, there's a reason why Dave is on everyone's list of references, both on and off record, in the seed space...  With the right team and proper training prior to managing OPM in the seed space, a 200 company portfolio can conceivably return the same and/or better performance as a seed portfolio with 30 companies.  

In fact, I'd love to see a seed manager never follow-on its initial investments and invest in every company that it had conviction can return the fund.  #Conviction.  If you place a $2 bet on every horse on a day's racing form to win, won't you end up making money when the 10:1, 70:1 wins once in a day's racing form?  Pick a good trainer to back and your bound to make money, regardless of the size of the field and the racing form.  

Thursday, May 2, 2013

Is Mauritius the Death Star for Indian Venture Capital?

Ever heard of Mauritius?  Probably not.  It's a tiny island 2,500 miles from India located off the coast of Madagascar in the Indian Ocean, which serves as one of the largest tax havens for Indian-based companies and foreign private equity and venture capital firms investing in India.  

Since 1983 India and Mauritius have had a tax treaty that permits non-residents to forego capital gains taxes on the sale of Mauritius-based companies doing business in India.  In addition, Mauritius levies no local tax on such gains, allowing Mauritius residents to avoid the approximately 10-42% capital gains tax applicable in India on the sale of securities.  Sounds like a great deal, and it has been for decades.  In fact, over 40% of India's foreign direct investment (FDI) comes from Mauritius, a tiny country of 1.3 million people. 

This very favorable tax treaty was recently thrown into the spotlight when British multinational Vodafone paid $5 billion for a stake in the communications divisions of Indian conglomerate Essar Group.  The purchase took place more than five years ago and involved several court orders with billions of potential tax dollars at stake.  Ultimately, in January of 2012, a Mumbai high court ruled that because Essar Group was a Mauritius-based company doing business in India, Vodafone did not have to pay any capital gains taxes on the acquisition.  

As a result, the Indian Finance Ministry and Securities Exchange Board of India (SEBI) are taking a harder look at the legitimacy of certain Mauritius-based companies doing business in India, and are requiring Mauritius tax residency certificates proving that a company has a business in Mauritius with bona fide employees. 

This is making it increasingly more difficult for venture capital and private equity firms to invest within India as the India-Mauritius treaty requires that a Mauritius-based venture capital fund have at least two directors domiciled in the country (or be there at least 183 days of the year).

Now don't get me wrong, being a venture capitalists investing in India and living in Mauritius (pictured to the left) sounds quite glamorous.  However, as an LP in an India-focused venture capital firm, I don't think I want any investment professional sourcing deals from the beautiful shores of the Indian Ocean.  This new bona fide domicile requirement is going to hit smaller firms with a smaller partnership. Moreover, this domicile requirement will also make it harder for smaller teams to execute cross-border investment strategies focused on the U.S. and Indian markets as two GPs will now need to also split their time with Mauritius beach-combing duties. I fear that this may significantly dampen the inflows of venture capital limited partner commitments to India.  This will be an interesting development to continue to closely monitor and should be top of mind when evaluating prospective managers in India.

Tuesday, April 30, 2013

Let's Take the "Micro" Out of "Micro VC"

I've rather quickly come to the realization that I hate the term "micro vc".  Using the term "micro" assumes that a "micro vc" is something less than a "regular" vc firm.  And if so, what is a "regular vc" firm?  If what the industry is really trying to say is that these funds are seed or early stage oriented, why don't we simply call them a seed fund or an early stage venture capital firm?  I think it's clear though that the "micro" is meant to signify how big the fund is.  Let's just assume that this is the case.  

Still, why don't we just simply call these funds "venture capital funds"?  Let's take a brief trip down memory lane...

In 1977, when Dick Kramlich, Frank Bonsal and Chuck Newhall founded New Enterprise Associates, the firm's first fund was $16 million in limited partner capital.  Later in 1979, InterWest Partners formed its first fund with a whopping $33.7 million in committed capital.  In 1972, when Don Valentine founded Sequoia Capital, the firm raised $2.9 million.  Greylock raised $9.5 million in 1965, Mayfield raised $3.8 million in 1969 and KPCB raised $8.1 million in 1972.  Even Oak, the behemoth that it is today, only raised $25 million in 1978... 

A more recent example is Fred Wilson raising $125M for Union Square Ventures I in 2004.  Fred at USV and Brad Feld at Foundry Group (which raised $223M for its first Foundry Group fund in 2007) are two prime examples of the fathers of a new era in the venture industry, where small fund sizes and tightly knit partnerships are remarkably similar to those funds formed at the industry's inception.

Unless we're assuming that today's "micro VC" funds are something less than a "regular" venture capital firm, which some may argue is true, I think the moniker of "micro" should go away.  If you're an LP and contemplating an investment in a venture capital fund of $100 million in fund size or less and the GPs of this fund take board seats, add value to their portfolio companies and entrepreneurs and are fiduciaries seeking to maximize shareholder value for their limited partners, they are venture capitalists and not "micro" venture capitalists.  This investment model is precisely the same as that blazed by the first venture capitalists of the 1960s and 1970s.

There inevitably will be certain funds that are raised in the coming years by entrepreneur #[fill in the blank] who leaves Google, Facebook, LinkedIn, etc. and has enough capital to become an angel investor, but at the point this person decides to manage other peoples' money (OPM), they are now a fiduciary and should be called a venture capitalist.  Some will be good and some will be less good, but they're still venture capitalists, not micro venture capitalists.  

If all of the public proponents of small fund sizes (e.g., Kauffman Foundation, SVB, etc.) are correct that small fund sizes can drive disproportionate value for LPs, let's simply call these institutionalized seed/early stage funds of $100 million or less, "venture capital firms".  If we need to bucket them in our endowment models or need to stereotype with the buzz word of the day, why not just call them "old school" venture capital firms.  If nothing else, let's just not call them "micro" vc funds anymore...!