Your Fund Size is Your Strategy

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One of our LPs often tells me, “Your fund size is your strategy.”

I was at a dinner with a long-time investor the other night and he noted, “the NYC seed stage ecosystem used to be so much more collaborative — what happened?” I still see NYC as extremely collaborative, but it’s important to recognize that our collaboration from a decade ago was often the product of scarce resources, not solely altruistic collaboration. NYC Seed stage funds were smaller and to close out a seed round often required other parties to be able to pool together enough resources for the founders to be able to reach their next meaningful milestone.

As the seed stage ecosystem evolved, virtually every one of these funds has gotten significantly larger. Round sizes have gotten bigger, but so have valuations, meaning that investors need to write even larger checks to acquire the necessary ownership to drive returns for their fund. When targeting 3–5% you can be highly collaborative. When targeting 15%, it’s much harder to be collaborative. With many of these seed funds now managing more than $100m per firm, they likely need double digit ownership to move the needle for their fund. This makes it significantly harder to be collaborative than when they were targeting 3–5%. This is further complicated by the fact that their most frequent collaborators have also scaled (requiring double digit ownership themselves) making it more difficult for them to partner with those that they have most frequently partnered with.

This doesn’t mean that these firms can’t syndicate deals, but it does mean the need to be far more selective, often with room for a single other major investor or perhaps two smaller ones. This is an unfortunate reality of funds getting larger and is a big reason why very few Series A firms syndicate deals — they need to concentrate as much capital and ownership as they can to make the the numbers work on larger fund sizes.

There are peers of mine that I often collaborated with several years ago that it would be incredibly difficult to do so with today. With our latest set of funds, we’re targeting north of 15% at our point of entry. Given that most founders don’t want to give up more than 20–25% of dilution, this generally means that 1) there is only room for players that are comfortable with less than 10% ownership and 2) we need to lead the deal as the largest check writer in the round.

This has a significant impact on the competitive advantages of a firm in the market as it scales. When party rounds were the standard course for smaller seed firms, connections were the scarce skill set, enabling access to deals led by other reputable firms. As these funds have become larger and rounds have become increasingly tighter, conviction becomes the scarcer skill set (i.e. can you lead and win the deal).

As someone who began my investing career outside of the valley, leading early rounds independently feels very natural to me. I knew full well that if a generic enterprise SaaS deal made its way to my desk from the Bay Area that it was likely adverse selection (sure enough, I lost nearly every $ I invested in the Bay Area). This forced independent conviction. Not by choice, but by circumstance — fewer investors were looking at those deals and categories. Our team has developed capabilities to source independently, develop conviction independently, and partner with those that can appropriately complement us as co-investors and downstream investors. We also capped our fund size to enable the opportunity for us to continue to collaborate with our partner firms, whereas had we raised a larger amount we’d have to be even more restrictive.

This style of investing isn’t for everyone, but I believe it’s the best model for us. Others very much thrive on collaborating with co-investors and prefer not to lead. Incredible investors like Semil Shah and Scott Belsky have turned down an incredible amount of capital to focus on doing what they do best (and produce some epic returns). As pros of the venture business, they recognize more than most how important these competitive dynamics are and have leaned in on the check sizes that enable them best to compete in the market.

Much like with startups, growth at all cost is a fool’s errand. In some select cases, scale can have advantages, but to pursue scale without recognizing its ramifications is a dangerous course of action. As firms grow, the fund size dictates the strategy and capabilities necessary to execute it.