Starting a VC Fund, Episode 3: Developing a Compelling and Memorable Story

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

I'm Charles Hudson, the managing partner of Precursor Ventures. We invest in very early stage companies, pre product, pre traction, pre everything. And we'll invest in 25 or 30 companies per year.

So in our last video, I just learned that basically most people that want to start a VC fund show up with a story that just simply sucks. And so we've learned one of the things one should invest a lot of time into is really building the story. And so the first question I have for you is like, how the hell does one go about that?

You know, the whole story development process is really hard because I think part of it is that you have to put your shoes, you have to put yourself in the shoes of the listener. And I think most people who start a VC story want to tell the story of themselves. Why they're unique, why they're special. And I think if you're the listener, the recipient, the limited partner, everyone thinks they're a snowflake. Everyone thinks they're special with their fun strategy. I think part of what makes this hard is you've got to really dial in on what actually makes your story unique. What's your actual points of differentiation and what are you actually doing. They're going to give you an edge as an investor.

And how do you start about that? How do you go about that?

I think it's really difficult. I think everyone should start with what is it that you truly believe you're here to do as an investor? Like when I started Precursor, it was clear to me, having worked at a larger seed fund, that the biggest seed funds were moving to a place where they were not going to take bets on people they didn't know, who didn't have traction. That was sort of the kernel of the idea. And I'm like, how do I wrap a story around this insight? And Precursor just started with that insight, which is that there's a bunch of founders who are not well served. They want to raise less money, they have less traction, they have less evidence. They're not a good fit for the seed funds that want to write a $2 million check into a 4 million dollar round.

So you found some insight. What made you convinced that this could work?

You know, I had the advantage of having sat in the seat as a partner at a seed firm and we routinely told those companies, you're too early for us. And at one point the light bulb went on. I said, well, if I'm at a seed firm which is nominally supposed to invest early and I'm telling people that we're too early, isn't it weird that there's something too early for seed? Seed is supposed to be the first stage. And what I realized is that, you know, the successful seed firms, and I think the firm I used to work was very successful, had gotten to a place where they didn't need to take as much early stage risk on average, on pre launch, pre traction companies. They moved on to a stage where they could do that for people that they knew well or who were repeat entrepreneurs or were spinning out of companies that were well known, but they didn't need to do that for the average entrepreneur. For the average entrepreneur, they could tell them, go raise a small amount of money from friends and family or angels, come back and see me in a year when you've got a product and symmetrics.

So what you're saying is basically you've found some insight and you had a very strong conviction that that insight could work out and that became the fundamental basis of your story. What came next? How did you take that story and matched it to the audience you actually had?

I think I had the same experience that lots of first time fund managers had, which is I had this insight. I was like, oh man, this is so obvious to me. I'm gonna go raise a funder on this strategy and it's gonna be easy. So I took that insight, I went and road tested it with other general partners at other funds I knew and other limited partners that I knew, and they weren't excited about it at all. Many of them told me, this is a bad idea.

All right.

What did you learn from that? What does one have to be aware of when you go out to such a market about the idea you have.

The stage of the industry, if you will, and how well it fits in.

I think the big thing I didn't appreciate was that most ideas when you're raising for a venture fund, you have to do sort of a self assessment and say, is the thing that I'm pitching, is it orthodox or unorthodox? And so here was my basic pitch for precursor. In a nutshell. It's going to be one partner, me, who's going to invest in 25 or 30 companies a year. We're going to invest at a relatively low price with a small check. We're not gonna get a lot of ownership. We're not gonna take a lot of board seats and we're not gonna be what I would describe as the classical canonical version of a hands on VC where we're really putting our hands in the dough and really trying to get deeply involved with the companies that we invest in. I said we're gonna pick really great people, we're gonna give them some support, we're gonna give them some time. But it's a different model. And at the time the orthodoxy of venture was you need a multi partner partnership, minimum of two people to be effective. So those two people could be a counterweight for each other's decision making. The only way to make money is to buy large. And by large at seed we're talking 10 to 12% ownership stakes in companies. You have to be very hands on, preferably taking a board seat in every deal that you do and leading those investments. And you have to have lots of reserves for, for follow on investments in your winners. So basically everything I pitched at Precursor was the opposite of what LPs believed worked at the stage where I was starting.

And that's one of the causes of why you say it was more difficult for you in the beginning.

And you know, I got some feedback from people who said, you know, there's four dimensions that matter. Team composition, portfolio construction, ownership math, and follow on strategy. You are unorthodox on four of the four dimensions that people are looking for. And I hadn't processed that until someone told me like everything you're doing on every dimension of your fund flies in the face of what people believe works. Which doesn't mean you shouldn't do it. It just means you have to accept and internalize the fact that you are counterculture on all four of those dimensions. And very few people want to bet on a four out of four different fund being different on one dimension, maybe two. You're still in the strike zone. For a lot of people when you get to being three or four degrees of difference, you're bordering on heretical.

So that insight was really important to, to your journey. Right. And so you said something about road testing it and so on and so forth. Because you did that, that's how you came to that insight. So how does one go about that? Like what is your recommendation? I have a theory of what my story is. How do I go road test it?

I think one of the challenges for road testing is the people who can give you the best perspective on whether or not your story hangs together are other VCs who've already raised funds recently or limited partners who like you as a person and want to see you succeed. Now, this is one area where I think if you're coming from within the venture ecosystem and have relationships already, you have an unfair advantage relative to your competitors and that you can ask your peers to scout your story and tell you what about it, does it make sense? And ideally, if you work in the venture industry already, there's limited partners that you know, whether they're investors in your fund or not, who can give you honest, valuable feedback on your own story. I think the challenge is if you're starting a fund from scratch, it's much harder to get that honest feedback and assessment on your story because you're not going to get feedback from people that are actually in the business of saying yes to new VC managers.

So if I am relatively new to the industry, what advice do you have?

My advice is, you know, unlike 10 years ago, I think there's a handful of new managers and established managers that are easy to access on Twitter. I think there's programs like Operator and First Coast Partners that are set up to help first time managers really engage with the community and get feedback.

Yeah.

And so I would try to plug into people who want to help you. And I tell everyone all the time, the people who can give you the best advice about what to do are the people who are N plus 2 funds ahead of you. So if you're starting your first fund, I'm sure someone else who's starting off from scratch can give you advice. The people whose advice you really want are people who are on Fund 3 because they're far enough away from your problems that they remember what it was like, but they're also far enough away from them that they know what it looks like on the other side.

Okay, so off you go and you get a lot of feedback back. What happens? Like what feedback do you typically will get and what do you do with it?

I think most of the feedback you get as a new VC manager is people tell you no. And so at some point everyone ends up in this situation where you have to ask yourself a question, am I wrong or are they wrong? Like, is it that, like the thing that's obvious to me is going to happen and it's just a question of time and I have a vision for the future that they cannot see? Or is all of the criticism, negativity and no's that I'm getting from people, is it actually pointing me towards a flaw in my model that I haven't really wrestled with? Or grappled with.

So what you're saying is you either will get feedback that helps you understand that what you're doing is wrong, or it's unpopular at this point in time or closer to what you said earlier, unorthodox. So the question I have for you then is like, okay, well, how do you know if you're wrong or if it's just unpopular?

I wish I had a really crisp answer for you. I think the line between unpopular and wrong is a very, very thin line. And I think sometimes the answer is, how much personal Runway and time do you have to live with your thesis before it turns out to be right? So, for example, if you were a crypto enthusiast in the early part of the 2010s.

There were times where it felt great to be long crypto, and there were times for cryptocurrencies and all the supporting infrastructure were really out of favor. If you had the ability to stay in crypto for a decade, you're probably feeling pretty good in 2021.

Yes.

If you had to bail and quit in 2017 or 2018 when crypto was not popular.

You just weren't able to sit with the thesis long enough for it to become true. And so one thing I always tell people is like, well, what's the timeline for your belief? If you're, particularly if you're a specialist fund, Getting the timing right of the transitions in your industry is really important because if the transitions and the timing and the inflection points take longer than you can stay in business, it doesn't matter how smart you are, you won't be there to reap the benefits.

So.

It must really suck to basically be unpopular but not have enough air to last until you actually can prove that you were right.

And you want to avoid that by basically making sure, do I have enough time span available to actually run with this? And so spend enough time thinking about that. What's another example of that?

I think the times where I think you're wrong sometimes is, for example, at Precursor when I started, a lot of people I pitched said, hey, you're buying really small stakes in these companies. Are you sure that you'll own enough at exit to make your fund model work? Like, what ends up happening if you own 1% of these companies? I'm like, well, if they're unicorns, we're fine. If we don't, the model doesn't work. And that was an area where I said, this is actually a valid criticism of our model. But I would argue that the point people were making. There was like a layer below it which wasn't like, oh, the ownership is too low. What I took away from this was like, I have not convinced people that we're going to find companies with our model that are so large that even a small ownership stake will produce a big outcome. So if their argument is like, well, the biggest company you're going to find with the precursor model with the companies you're looking for is a billion dollar company and you're only going to own 1%, so the most you'll ever make is $10 million from a single position. I agree with them. That's not an interesting fund to back. And what I realized was this conversation of ownership was really about company quality and ability to select and win deals. And as soon as I realized that, like what they were really saying without saying it was like, hey, I don't know if you're a model is going to generate companies like an Uber or an Airbnb, some of these big outlier companies that can move the needle on a fund. And I would tell people, well, if we can find $10 billion companies, doesn't that solve the 1% ownership problem? They'd always say, well, of course it solves that. And I'm like, okay, so really what you're really telling me without telling me is your concern is not so much about ownership, it's about what scale of companies are we gonna be able to access with our model. And that caused me to go back and like change our storytelling a bit and say, hey, look at the enterprises we're paying. We can get 20 or 50 x multiples in our initial check net of dilution even at billion dollar outcomes. And so if your concern is like, does a billion dollar outcome matter for a fund, I can model for you why that happens. If your question is about can we find multi billion dollar outcomes, that's a different conversation altogether. That's not about ownership, that's about our ability to select great companies.

Okay, so basically what you're telling me is you noticed through this review process that some elements of your story were unpopular. And what you ended up doing is refining the story to have better answers for those aspects of your story that were unpopular.

One thing that really helped me is I kept a log of all the meetings I had and what, without being too specific, what parts of the story did I feel like didn't land with people and where was I getting the most pushback? And very quickly I realized that like the pushback for us was around the number of companies in the portfolio, the small size of the team and the relatively low ownership. So I'm like, I have to solve for this sort of Bermuda Triangle problem that I call it the Bermuda Triangle problem of Precursor, which is small team, lots of companies, low ownership. I have to give the LP a very satisfying answer about why that's not a problem. But it's actually, as I tell everyone, it's not a bug of our model, it's a feature. The feature is that we get 75 to 80 opportunities per fund to find a handful of companies that will generate multi billion dollar outcomes. So don't focus on the fact that every company won't be. We have 75 or 80 shots to find one or two companies that are really special. And if you don't think we can find one or two, you absolutely should not invest in our fund.

Yes. And that made the argument a lot stronger. So let me ask you this. What if you come to the conclusion that you're wrong, you're actually something is wrong with how you think about it? What's the advice there?

I think there's two ways to be wrong. I think you can have a flaw in your model that you can't reconcile. Like if I had said, wow, even with $100 billion company and precursor, it doesn't return the whole fund based on our ownership math, I would say that's a flaw. That's a fatal flaw. $100 billion crazy outlier company should return your whole franchise. You should return all the money you've ever raised from LP several times over. I didn't have that problem. But if I had, I would say this is fundamental. Like, even the greatest outcome I can imagine doesn't move the needle from our fund. We've constructed the portfolio incorrectly.

And then what do you do?

Then I think you have to go back and look at your model and say, well, what do I have to change about my strategy or approach such that an outlier company like that would move the needle? And there are things we did differently at Precursor. I'll give you one counterintuitive one.

I realized pretty early on that for our model, it's more important to be in the best companies than it is to hit some arbitrary ownership threshold. Because our fund is so small, if a company's going to be a large far outlier, it's better to have even a small check in that company and be a part of it than it is to say no out of structural reasons. And like, wait for the one where you can buy 5 or 6%, 1 or 2% in a really far outlier outcome for a fund of our size matters way more than an on model check of 5% to a company that's not special.

Yeah, that's a cool example. All right, I want to wrap this up by.

Asking sort of like, what's one more thing that you should watch out for on. On just, like, building your story and how it gets communicated.

You know, I think the most important thing is that in the same way that VCs have their own language about how they talk about companies that they don't invest in, LPs have the same vocabulary for talking about funds that they don't want to invest in. And I think until you understand how to decode that language, it's very easy to take their feedback literally. And oftentimes what I find is that, like, the most useful thing you can do is find a couple of people in your orbit who can tell you the truth or who have access to.

The truth or can translate.

Or can translate. And I was lucky. I had a couple of LPs who never invested in Precursor, but spent a lot of time with me in the beginning, and they were able to tell me, this is why you're not raising right now. Like, I can listen to your story and I can tell you as a limited partner, as another vc, this is why I think it isn't landing. And I needed that. I needed somebody who was on the other side of success to tell me this is why it isn't working. And that's something I'm really excited to do for other people who are trying to raise funds.

I also believe you once told me that you have this, like, rule of three things that you think a story has to have, because the decision.

The place where the decision of for them investing into your fund gets made is this when you're not in the room.

It's interesting. I took some of the fundraising feedback I give our portfolio companies and I applied it to what we do at Precursor. And all of our portfolio companies are probably. I feel like a broken record on this. I tell them, if you want to raise money from a VC fund, your pitch has to clear three hurdles. It has to be unique, it has to be compelling, and it has to be memorable. And you need all three, because once you leave that partner meeting, having given your pitch, the deliberation about your company is going to happen without you in the room. So you're not going to be there to fill in the details. You're not going to be there in the room to burnish a point. The person who's your champion or advocate has to be fully empowered to tell your story in your absence.

And I feel like uniqueness as we talked about last time knocks a lot of people out of contention right away. It just ends up being this person's great. They went to this school and worked at this company and everyone rolls their eyes and says this sounds like 99% of the people that we meet next.

Yes.

And it has to be memorable. Like the person who's your advocate has to be able to tell a very succinct and crisp story about your fund and why it's special.

And memorable means the thing you told them in that one on one meeting they can remember and repeat it at their investment committee and it has to be compelling. And compelling means in a world of scarcity they will choose you over other options.

Awesome. That was a really awesome discussion around how to build your story. I certainly learned a lot. I hope you guys did too. Thanks for listening.

Thank you.