Episode #28: Fund 1 Over Performance Math, Media and Content Runs VC, Fund Manager Patience

For any content piece I could find on the Internet, I could easily find another VC who would say it's dead wrong. I tell people think of these things as inputs that should shape your thinking. They should never tell you what to do or how to do it it's.

The week of April 14th. Welcome to the Learning Corner, a Precursor Adventures podcast.

Welcome to the Learning Corner by Precursor. I'm Mia Farnam and I'm joined by our GP and Managing partner Charles Hudson, where we'll be talking through the articles and Goodreads that caught team's attention over the past week. Our first topic is Steve Kim's LinkedIn post, which explores the theory around fun ones and how they often produce some of the best performing venture funds. The core argument is rooted not in the experience or hustle of the fund manager, although that obviously helps, but more so in the math. So fun ones statistically have fatter tails, meaning they're more likely to deliver either outlier returns or dramatic underperformance due to the compounding effects of skill and chance. As a result, exceptional fun one managers can gener returns that outperform their more established peers before regression to the mean kicks in with subsequent funds. So the root of this fund one success is based in compounding effects of skill and chance. So when I was thinking about this after reading it, my question was is it possible for experienced fund managers to quote unquote replicate skill and chance in later funds to create this type of repeated, outsized return from your perspective?

I always like reading Steve's work. They're very analytical over there at Virtus. So it's helpful when you're a fund one manager to get things like that's published. So I think the answer to your question, Mia, is yes. And I think it's for a couple of reasons. When I think about what you have on your plate as a Fund 1 manager, there is something special. Usually if you raised your fund you had some thesis on the world and if you outperform, usually that thesis on the world was true in that moment. So if you're a specialist fund manager, maybe there was some inflection point in the category that you are focused on that allows you to get into all of these really interesting companies. Maybe it was a founder archetype where I think about, you know, the early days of Felicis when Aydin was really focused focused on the ex Googler network. Sometimes you have these moment in time kind of like arbitrage opportunities that you see that other people don't see that can give you outperformance. The other thing on a practical basis is you're not as busy with the other stuff in this business. You don't have a legacy portfolio of companies to support. You don't have a larger staff of people to manage. The job is simpler and in some ways it's cleaner and purer. And I think you can recreate this outperformance if you have another one of these, like big insights on a market shift. Which is why I think so much of VC writing is focused, focused on trying to figure out is X trend the next big paradigm shift? Because if it is, it creates the situation where you can have dramatic outperformance. Like, you know, if you were early on the Internet, if you were early on mobile, in some ways, if you were early on crypto. It's unclear to me that being early on AI, other than sort of some of the foundation models will end up being a great investment strategy. But we'll find out soon. So I think if you can recreate that beginner's mind and find one of these big technology shifts and actually have the freedom and time to actually invest and take advantage of it, then yes, you can replicate the performance. But that's a lot of conditional statements.

It's fascinating. It also assumes that you're identifying the arbitrage opportunity way before everyone else is. And to your point, have access to and can make those investments quickly. But to your point, working in an earlier stage fund that has not as much infrastructure to create barriers to make quick decisions probably is a, is a massive way to kind of have a leg up.

I mean, the other thing I've been thinking about a lot lately is historically venture capital has been a business where general partners invest in their immediate network and that proximity is a good signal for quality. And the older you get, the fewer of your friends start companies. Yeah, the ones who are successful retire, the ones who are unsuccessful kind of give up on entrepreneurship and you get further and further removed from where company creation is happening. And I wonder if part of this is also the age at which most people tend to start their first funds is usually when their friends are in their prime. Entrepreneurs, if you think like most fund managers I meet, are somewhere between very late twenties to mid thirties and oftentimes that's a period of time where a lot of people in your network are either starting companies or are actively involved in managerial roles at meaningful companies. And as you get older, your network gets further removed from company creation. It's been my experience you have to work much harder to stay close to the metal.

Yeah, it leans into another question, which is the dark side of Fund one performance is that they drastically underperform. As we mentioned earlier. Taking into account some of the insights from Steve's post, I was wondering if we wanted to zoom out on any specific trends that could lead to that outcome. I was trailing down on some of the messages that were responses to his post and a lot of them were saying like the great ends of this take into account that folks have smaller funds writing until correctly valued company is enabled to move pretty swiftly. So I guess the opposite of that would probably create the inverse scenario of the dark side of Fund one outcomes being a little bit more underperforming.

Well, I think we've talked about this like the opposite of fortune is misfortune. I talked to an LP this week who told me like it's really hard to escape a bad vintage year. And he's like the only way to escape it is to not play. And so it's very possible, I think about the COVID era, it's possible that there were good fund one managers who simply chose a really bad market environment in which to do their first fund. Those first funds will underperform and unclear to me whether some of those folks will get a second shot. And we might not actually know if they're any good because of the vintage year effect of when they started. And so it can cut both ways. Like starting at the wrong time can really set you up for underperformance.

I mean it reminds me of the post that we talked. I forgot who wrote it. But it's not like, oh, I'm going to start picking lower valued companies now. You can't just start sacrificing on that just because you're like this is how I'll continue to win and maintain performance. There's so much macro that you have no control over which to those fund managers defense that will ultimately result in if the fund's going to have an another go at it. And a lot of that was completely out of their control.

One of the biggest pieces of advice I got when I got started was from other experienced gps who were just like make sure your first fund is awesome. If your first fund is awesome, it will buy you a lot of time to figure things out. And I think the same goes I know other venture firms who feel the same way about new gps. Make sure that their first one or two deals that they work on are awesome so that they get the reputational flywheel of being associated with a good company and so more good companies seek them out. And if you can manufacture or create circumstances where that happens, it sets everybody up for success.

Well, it's a good dovetail into our next topic, which is from Paul Smellera's blog VC Content Club titled the Next Great VC Firm will be Built like a Media Company from Day one and it outlines why content strategy will become table stakes for emerging funds. He argues that attention, not access, will become the ultimate currency and venture winning the hearts and minds of founders, starting with building belief in narrative power at scale. So the most successful firms will treat content creation like editorial strategy, building repeatable formats and founder first story storytelling and multi channel evergreen assets that extend the firm's influence far beyond traditional sourcing. And it's funny, Aaliyah who's on our team, she commented to me that this piece reminds her of the recent New York Times piece what Is Venture Capital Now Anyway? Where it compare the new and old guards of venture capital and what models are sustaining momentum over time. And media and content were one of the key features in that piece that differentiated the more cottage industry versions of venture capital from what we see today. So my questions are 1. How much do you agree with the this type of narrative? And then two how can you strike a comfortable balance of continuing to put founders at the center while also living in this reality of building a more public brand for your venture fund in parallel?

I think it is important to acknowledge that there are some established brands who simply don't need to do this stuff. Like they don't. They're brands that are well known to and by founders. But I'd argue, you know I've been in venture 20 plus years. Even your Sequoia and Kleiner work harder to be top of mind with founders than they. I'm not saying they didn't work hard before. I think there's a more of a recognition that there's more competition in the business. And so if you just think about it and say remove the word venture capital if you're in a business where competition is increasing and the underlying product money is a relative commodity, what if it's like toothpaste? Most of the energy and activity doesn't go into R and D and making new no offense anyone who listens to this podcast who makes toothpaste but a significant amount of the energy goes into marketing the features and benefits of your toothpaste such that when the consumer goes to Target or their favorite store and sees the wall of toothpast boxes, they pick yours and I think in many ways winventure was more of a cottage. You know, the post talks about like the whisper, the old whisper. It was easy. Founders just talked to other founders. There were relatively few firms you could go to. It was really important that founders said good things about you. But we've dramatically increased the top of funnel of entrepreneurship and not everybody knows every firm. And so if you're a brand new firm and you're trying to break in, I always tell people you should assume that the really good founders are getting advice about whose money they should take. They're getting that advice from other founders. They're getting that advice. How do you insert yourself into conversation? And content is one way you can do it. And I think 20 minute VC and Thomas Tungas are like two really different polar examples. You know, Harry makes a ton of podcasts and is really active and I think that has been unquestionably important for his brand, even based on the most recent fun announcement that they had. And Dimash just kind of cranks out data informed posts on a regular basis and has been doing that for a really long time. And those are like content strategies that appeal to different audiences. I also think there's another consumer for VC content that isn't the focus of this article. It's limited partners. I think limited partners also want to invest in funds that are brands. And I think increasingly we're moving to a world where individual GPs are mini brands and founders choose mini brands over firms. I think it's been heading this way for a long time. You know, some of this me is weirdly parasocial. I've talked to founders and like you don't actually know that person. You've just read a bunch of their articles and consumed a bunch of their Instagram stories. You actually don't have a bi directional directional relationship with this person. You're a fan, which is great. Like you're a fan, wonderful. But I do think in most ways I think it's a net positive for our industry that you can use content to launch a new firm. I think that could name others beyond Homebrew. And I think what Sarah's done with conviction, she's I think done a really good job of putting a stamp out there. So the two things I tell founders is, or VC fund founders, people who are starting their own funds. Find a content format that you enjoy because producing content in a format you don't enjoy will feel like work and you will inevitably quit doing it because at some point there'll be something more important to do. And second, make sure the content you're creating is attracting the kind of founders that you want to attract. So if you want to be a sh. You know what, poster on X and be snarky, be prepared to attract the founders who respond to that stuff. Yeah. If that's not who you want to be, don't do that. People like, well, I should. I want to write. I want to blog more. I'm like, do you enjoy writing? They're like, no. I'm like, well, then you should pick a different medium because you're not going to do it.

Like, you can tell who's writing with AI. It's very obvious. Everyone, as a psa, some of it is very bad.

And I the better I know the person. I actually did tell somebody. I was like, you need a new ghostwriter. And he's offended. And I was like, no, your ghostwriter does not sound at all like you.

I'm stuck on your toothpaste example. It's funny. And I'm thinking about myself in the founder's shoes. I go into the supermarket, I go select my toothpaste and the wall of toothpaste. They all say that they basically do all these amazing things that are unique and different and going to help and improve my health. I assume they all do the same thing. And I think that's my question about this comparison at the end. I'm just looking for toothpaste. I just need it to survive. I've never had the outcome though, of a toothpaste draft drastically being the reason why I'm going to the dentist and having cavities. So my question to you is, how much is that live in Venture where it was marketed as such, and it actually does the inverse of what you wanted to creates a negative impact for the trajectory of your company.

I think I've seen people with content create expectations for founders of what? You know, the money I'll call the Money plus bundle. You're going to get Money plus something else. Money plus advice, Money plus platform services, Money plus this operator network. I've certainly seen some toothpaste that purports to cure cavities. And so people buy it and they're like, oh, I still have cavities. And I'm like, you know what? Their go to market support team can't help you if you don't have product market fit. It's not a failure of their platform team. It's a failure of your company to find product market fit. And I have seen people who've been like, wow, I was promised the moon and the stars. And I didn't get it. I do think for me, the toothpaste analogy stands because every now and then in toothpaste you get something like whitening or you get brightening or you get natural toothpaste. You get these like different flavors. And all those different flavors are designed to appeal to people with different preference functions. Yeah. And so some people want Crest and Colgate because you can get it everywhere and it's very reliable. Other people like Tom's. Other people want whatever the new Instagram influencer social media toothpaste is. I think about a lot of the people that I meet. And it's funny, when I talk to founders, they'll bring up like a Nicole wish off. They'll bring up people who have what I would describe as like pretty strong points of view online. And I think it creates in the mind of founders a point of view about that investor in a way that if you're just kind of doing your job and quiet, people might not know you and might not. By the way, there are also people in this business who are wildly successful who produce no content.

Right.

We do none of this stuff too. Who are emerging managers. And those people I find tend to be embedded in networks where content consumption of that type doesn't matter.

And they've created something a little bit more proprietary, not to overuse the word, but for their deal flow. My one last question here and again, putting myself in the shoes of a founder, Paul's claims that the most successful firms will think like a newsroom about your entire platform. And I can certainly see this executed well. And so he mentioned Hunter. I think Stephanie and Artemis does a good job. Olivia at Forum has been starting to put out content of her own. But like real life newsroom rooms, it's easy to start launching really biased content in favor of your own fun strategy beliefs and venture at large. And I think from a founder standpoint, it does create a very noisy LinkedIn. I just chatted with one of my other friends who's a founder and she said I can't even go to LinkedIn. I just feel like I'm so overwhelmed by self promotional content. So founders are just perhaps a bit overwhelmed by content and just fall numb to all narratives. So I'd love to hear what you think about this and kind of how to guide founders in the direction of how do you find people who are putting out the content that you like and also being open minded about what that means.

I think you should never take something you read and immediately go implement it at your company. I Don't care who wrote it. After the Toby AI internal memo, a few people were like, we're doing this at my company. I'm like, why? We have 50 people. Why? Like, are you sure this is the right answer? So I don't care who wrote it. Don't blindly take someone's content piece. Second. I often encourage founders think about the lens through which this person views the world. And with that lens, why is what they're writing true? And do you look at the world through the same lens? And I think for any content piece I could find on the Internet, I could easily, easily find another VC who would say, it's dead wrong. Why it's great to be a solo founder, why you should never start a company alone, why you should raise the most money possible. And so I tell people, think of these things as inputs that should shape your thinking. They should never tell you what to do or how to do it. You know, not everybody can watch two hours of content from one point of view and two hours of content from the opposite point of view. For some people, that's, like, very enriching. They're like, oh, I have a more complete picture. For other people, it's overwhelming. It's too much to process. So just be honest about who you are. I was listening to this great. I almost put it in the channel this weekend. There's a really good Capital Allocators interview with Howard Marks. It's an older interview that. It's a pretty recent interview, but he's talking about private credit and talking about when he writes memos. He's like, I write memos when I have something to say that I feel like others haven't said. And I was like, that's kind of like my writing process too, which yields about one article a month maybe, and some months, it yields nothing. And so I think if you're like, hey, we're going to post on LinkedIn every day, you will become like cable news. Hey, we're on for 24 hours. So whatever. We have to write about something today. What's the something? And so I've never wanted to be. Be beholden to a content calendar where, hey, it's Tuesday. You gotta publish something. And so I do think some people have taken the content thing too far. I talked to somebody who's been in the venture services ecosystem for 30 years, and we were talking about Josh Koppelman at first, Sean, and he's like, the thing that they got right is almost every piece of content they publish has the founder as the core audience. And has something valuable for founders to read. It's very rarely about first round is awesome. Like first round review is like these are good articles and these are situations you are likely to encounter as a founder founder and here are some it's kind of a mini mba. Here's some frameworks to think about when you encounter this situation and I think ironically that's kind of the best way to get known is for creating things that value not by being self promotional.

Totally agree. I would say like on LinkedIn, I try to diversify what things I engage with because I know similar to any other social media platform, it will create things that it thinks that I like and then all of my content will look very similar and it'll all be saying the same things. And the one thing I will say is I echo just find a form of content that you like to create but also that you're good at creating creating I personally Hence why we're doing a podcast. I'm very long winded as pertains to writing, so I would never be launching Venture Reflections like Charles would. It's just not my medium. Our final topic is a recent LinkedIn post written by Jenny Fielding, who's the co founder and managing partner at Everywhere Ventures, which reflects on the long feedback cycles of early stage venture. She recounts how it took five and a half years of investing with no liquidity and plenty of second guessing before a surprise acquisition by a Fortune 500 company returned her fund several times over. So despite the success, she finds her herself doubting her firm's momentum, only to be reassured by moments like recent week where five portfolio founders received term sheets from top funds. So she highlights the importance of patience to remain calm throughout the rollercoaster of an early stage vc. I'm sure Jennie's sentiments ring true for a lot of early stage venture funds and managers that we've talked at length here about the importance of patience in a market like the one we're in, but also honestly, always in venture. Just wanted to get closing thoughts on that one from you.

You that one definitely made the rounds in my VC manager. WhatsApps like the amount of public commentary on that article is maybe a tenth of the private commentary I've seen. Yeah, and I think if anybody other than Jenny wrote it, I'd be like, this is maybe a humble brag, but it's really honest because I know Jenny and that sounds like her. I think for a lot of people, including myself, that's what 2023 in the first half of 2024 felt like because we went from an era where I think a lot of LPs who invested in precede and seed stage funds were like, yes, we want to see performance, but we also understand this is a long game. Performance won't show up overnight. And it felt like LPs. We're going to give you the time for things to mature. And then between interest rates going up, public markets being volatile, LPs just needing liquidity. Suddenly, for a lot of precede and seed managers, there was this very pointed question like, where's my money? Yeah, where's the dpi? And I think for a lot of us, I won't speak for everyone else. For me it did cause moments of doubt where I was just like, wow, it has been a while. We haven't returned as much money as I'd like. What if collectively we're not as good at this job as we thought? And then, you know, you get a secondary here or there, you get some markups and you feel better. But I think this is the hardest emotional roller coaster part about being a VC. I told one of our LPs over the weekend, you know, I talked to 100 to 120 portfolio companies a month. Maybe 5% of them are just on fire, doing great. The rest of them are somewhere between completely struggling and like chugging along and the weight of doing that month after month. Sometimes it's hard to just continually look at a big portfolio and a large basket of companies and say like, where are the winners? And you know, we have a few companies in our portfolio that emerged in the last two years and that's a 10 year old fund. And I assume this same will happen in funds 2, 3, 4 and now fund 5. We will have late breaking winners and we will also have companies that we were really excited about for the first seven years that will falter. And so I think there was very little patience in our business both on the part of LPs and GPs in the last two years. Because I think everybody wanted to know, like, am I okay? And it feels like slowly but surely we're going back to a new equilibrium which will be more patient than that time, but probably not as patient as days passed.

Well, we are all out of time for today. Thank you Charles for stopping by the Learning corner and thank you to all our listeners for popping by. Please like and subscribe and we will see you all next week. Thanks.