Starting a VC Fund, Episode 2: Stand Out or Burn Out: Does your Story Suck?

Hi, I'm Patrick Evis. I'm the founder and CEO of MindMaven, an executive coaching firm that helps VCs and CEOs free up about a day, a week of time and then invest that time into relationships.

I'm Charles Hudson, managing partner at Precursor Ventures. We're a very early stage venture capital firm focused on being the first investment, first investor of record to really early stage companies. The idea is that we're going to back really promising people pre traction, pre revenue, pre evidence, pre everything, 25 or 30 times a year.

All right, and we're here to talk about how to start a VC fund. And so what's the first thing you have to worry about if I think I'm ready to go talk to some LPs?

I think the most important thing if you're going to start a VC fund is you have to have a great story. And a great story is sort of the reason why your venture fund needs to exist and how you're going to help entrepreneurs and generate great returns for your LPs.

And what's the first thing I need to know about my story?

Honestly, Patrick, I think most people's stories suck.

Well, really, why? Tell me more.

I say this in full honesty, knowing that I think the first version of the story I told about Precursor wasn't very strong. If I were to boil down what most people's stories sound like, it's something like this. I'm a really smart person. I've got a really great network. Founders love me. I've probably been a part of or surrounded or a small angel investor in great companies. If you give me your money, I can scale up what I've done in the past. It ends up sounding very generic. You end up sounding like 99% of other people who are starting funds.

Isn't that the biggest reason of why people think they, they want to do it? And if so, what should they do differently?

I think most people honestly believe the narrative I just told them, which is that they're smart and they have access to great companies and that they should be trusted with lp. I think the thing that they forget is that in the same way that I as a vc hear thousands of pitches a year and can say, oh, you're the 10th company that told me you're going to do a B and C thing and X, Y and Z way, LPs are the same. You might think you have this super differentiated story. You have this like world class network and access to founders and the LPs sitting there saying you're the 10th person this week who's told me you were early at Facebook. You know all these great entrepreneurs. The question is, can you build a story that really stands out in the marketplace? And I'd argue there's only a couple of ways you can do that. There's sort of two dimensions. One is like, are you a generalist or a specialist? You know, specialist being you have some insight on a particular market or technology segment versus a generalist. The other one is like, is there something structural about how venture capital works today that you've identified that your firm can exploit in a way that other people don't see?

So like, like tell me, tell me about some examples that you have that, that you know of or that you know helps, maybe even your own.

I'll tell you about some of my friends that's probably more fun than talking about Precursor. So one of my good friends is, is a gentleman by the name of Sunil Nagaraj who started a fund called Ubiquiti Ventures. And his tagline is nerdy and early. And his whole thesis is I'm going to find these really technical founders that have a technology insight in the problem they're trying to solve, but maybe don't have great business instincts. I'm going to be a hands on partner to them. I'm going to have a concentrated portfolio of a relatively small number of companies. I'm going to work with them really early and through guidance, coaching and hands on effort, I'm going to help them take this technology insight they have and turn it into a company. And he's got a great track record to point to. You know, he was an early investor and sponsor of, of auth0 when he was at Bessemer. And that's a company that recently got acquired for almost $7 billion. And I think that's the thesis you could say, all right, you could build a brand as an early stage VC that says I want to find really early traction light or traction free founders who are deeply technical but need a partner to help them build the business. And you could argue that like you could build a unique brand around that thesis. So that would be a great special strategy.

That's the specialization track that you basically can pick, okay, and then the other one.

So I think the other strategy, and I think Precursor is much more in this lane, which is you identify something structural about venture capital that's broken where you're uniquely positioned to address it. So I would say, for example, going back years, I'd say Y combinators really did this in the early days, I think they found these technical founders who didn't think of themselves as business people but had the ability to build product. NYC coached them on the business of fundraising because at the time the VC industry didn't do a good job of meeting the needs of technical founders who didn't present well. And what YC helped a lot of these funders do was figure out how to present their ideas and concepts better and generate the traction investors wanted to see. I'd say in the modern era, I look at people like Locky Groom and Josh Buckley and I think what they're doing as solo capitalists, it's pretty disruptive to venture capital. You know, most funds have a stage focus. If you're a seed fund, you only invest in seed stage companies. If there's a great series A round and you missed it, you don't do it because your lane is seed. And I think with these solo capitalists like Josh and Locky and Elad Gill and others have done is they've sort of broken this stage dependence model and venture and said, hey, I have access to great companies at series C, D, B, later stage than you would normally expect an individual operator to be able to lead that round. I can get founders to take my money as a lead investor. I can price and set terms for these rounds and cause them to happen. That's highly disruptive to the traditional model, which is like if you're going to raise something beyond a seed round, it's going to come from an institutional VC firm and they've been able to get into and lead rounds for great companies. And I think that's a structural disruption the same way that I think precursors are structural disruption in the sense that seed firms are focused primarily on either post traction companies today or founders that they already know and we're backing people that we don't know pre traction.

So yours and the other story is basically an example of where if you're raising a fund, figure out something that you think you can innovate on or can change or disrupt the existing situation because you think there's a structural flaw in how this industry currently runs and then basically run on that story and convince people that you can actually make that happen. And that's basically your story and sort of worked out for you.

And I think what people underestimate is that the established incumbent funds in venture are very effective. So for example, people tell me like, hey, I'm going to start a brand new generalist seed fund. I'm like, great, how are you going to beat first round for the top of market most competitive deals? How are you going to beat them? And if you don't have a strategy or an answer for how you're going to beat the very best incumbent, see seed firms. It's very difficult to tell a story about how you're going to generate great returns because there's firms that have had 10 or 15 years to build their brand, develop their expertise, their network with co investors. The product they offer to the entrepreneur is actually a very good product. So if you're going to compete with the very best generalist seed firms, you have to have something special or unique about your offering that's going to cause the best entrepreneurs to pick you over them.

So that's for example, where specialization would be very helpful if you're picking an area that is already really well occupied by very strong leaders. Just got to have some edge to your story.

I agree. And I think the downside of specialization is that if the theme you've picked as a specialist becomes mainstream, the very best venture firms will pick up on that theme and the advantage you had as the specialist is eroded over time. So I think there was a period of time where Fintech was a specialist theme. Even going back to a firm like Emergence capital, it was SaaS. The SaaS. SaaS was a specialist theme. Most VC firms didn't believe in cloud based, which sounds crazy to say today. Yes, I believe cloud based SaaS was a thing and so Emergence had a run. Were simply by believing in that theme and being well positioned and being the experts on it, they saw the best deal flow. But now I would argue, I don't know a single great top tier venture firm that doesn't have at least a couple of partners laser focused on SaaS. So SaaS has become more competitive. So if you're a specialist, I think you also have to have a plan for how do you evolve your firm and your brand as the thing that you're working on becomes better understood by others.

So the moral of the story here is basically invest a lot more time than you think into your story and build a really good story that actually convinces those LPs that you are in some form or the other unique or doing something that allows you to be wildly successful. Is that a fair summary?

I think so. And I think the challenge for a lot of people is, you know, if you come from the VC industry and you have relationships with LPs and other VC firms, many of them will give you honest feedback about whether your story is in Fact landing, I was fortunate. I had spun out of Softech, Uncork and I had LP relationships where I could go to them before I was really in market raising our fund and road test the story. A number of them told me this isn't compelling. It doesn't hang together. I'm not excited about what you're telling me and here's why. And for example, for Precursor, when I went out in the beginning, I told people, we're going to find all of these companies that are earlier than what seed funds find. And a lot of LPs said, but my seed fund managers tell me they're the first institutional round of investment.

So what are you going to find that's good that they don't find? Because they're basically telling me that they're looking for the same kind of company that you're looking for and they have great returns. So isn't it reasonable for me to assume that you're just going to end up with adverse selection?

That's right.

And it took me a year to sort of piece together a story that both recognized the reality that, like, seed funds have excellent access to startups and that there was an underserved population of founders that they weren't meeting.

All right, which means we got it like jump and produce another video and that is talking about how to build a really good story.

So.

So I'd say that's what we're going to do. Off next.

Coming up next. All right, perfect.