Building a seed stage venture firm

Roger Ehrenberg

Feb 25

This is a topic I think about — a lot — and have done so for the past 10 years. I have sparred
with many on issues of portfolio construction, follow on strategy and more. But it was my
friend Micah Rosenbloom’s recent tweet that got me thinking about the nuts-and-bolts of
firm building, and that perhaps our experience at IA Ventures might be a useful story to
share.

When I decided to start the firm in the middle of 2009, the environment for starting a
venture firm sucked. Hard. It did for pretty much every other financial services business as
well, as institutional LPs were still licking their wounds from the financial crisis and trying to
figure out the best way forward. They had been risk-on for such a long time, that getting
whipsawed had messed up their liquidity positions and asset allocation models, causing
them to shift to risk-off with a rapidity not seen in my lifetime. In any event, as an emerging
manager (which wasn’t really a thing a decade ago), I had nowhere to go in the traditional LP
world. I could get any meeting I wanted because of my angel track record and terrific
mentors, but I knew with absolute certainty that I wouldn’t have a traditional venture LP
when I held a first closing of IA Ventures Fund I in January 2010. That said, I made a series of
decisions early on that laid the foundation for adding institutions to our Fund I final close, as
well as securing a supportive and blue-chip investor base for Funds II and III. And it is these
decisions and strategies that I will share here.

Fund I: Communicate a clear plan and invest in long-term relationships

Assuming that you’re not spinning out as a senior partner from a marquee firm and that
raising Fund I is anything but easy, there are several things you can do in the process of
setting up the firm to enhance your chances of raising Fund II and including institutional LPs
in the mix. First off, articulating a clear strategy — in essence, your product — is absolutely
critical. Think about your firm as a startup, because it is. When you’re looking at a very early
startup, what might you consider? Firm vision? Product mission? Scale of market
opportunity? Quality and chemistry of the team given the vision and the mission? Guess
what: sophisticated LPs, institutions or otherwise, are thinking of you in exactly the same
way. Are you a startup worth investing in? If you’re not thinking about it like that, and having
the empathy to put yourself in their shoes, than the likelihood that you’ll successfully attract
and retain top flight LPs is very poor. Why should you be one of the few new relationships an
LP is going to initiate this year? All of this points towards creating a product, e.g., your
strategy, source of differentiation and competitive advantage, that is flat-out compelling.
Part of this will be your approach to deal sourcing and company building. Part might be your
specific background or the backgrounds and chemistry among you and your team members.
Another area could be deeply-held beliefs around how certain markets might unfold. Finally,
a clear approach to money management, bet sizing, ownership and follow on strategy, will
also play a part in how LPs perceive you. Being wishy washy on any of these dimensions will
be damning and likely relegate you to a bunch of polite responses but little follow through.
But if you are crisp, clear and honest in these discussions, and keep these relationships
updated on your progress, you are keeping open the possibility that these institutions might
join in Fund II, or if you really get off to a great start, participate in your final Fund I close.

Fund I planning at IA was all about creating a clear plan of how

we’d create a firm with a strong brand both with respect to theme
and how we’d work with founders. I came up with the notion of
branding IA around “Big Data as an Investable Theme” in 2009 (which
was, believe it or not, pretty novel at the time), and then set out
to recruit my partner Brad Gillespie, whose giant brain and work
experience when coupled with my angel track record and Wall Street
derivatives and trading background made our story credible. This
was our first “innovation”. Our second critical bet was around
running a concentrated, ownership sensitive, seed stage venture
playbook, where we’d own a lot, really dig in with founders to see
if there is a venture scale company to be built and, if so, lean
in hard while there are still outsized cash-on-cash returns on the
marginal check to be secured. We started running this playbook from
the outset, even though we only had raised $17m in our first close
in January 2010, writing $750k checks for 12–20% of very, very early
stage startups. Was this kinda risky, especially not knowing exactly
how much we’d be able to raise later in the year? Hell yeah. But
how else could we prove our thesis that our little crappy NYC-based
emerging venture firm could identify and lead rounds in interesting
companies that we had no business leading? We went all-in on proving
out our model, and decided to live or die based upon what we could
prove in the first 6–9 months of 2010. We told the institutional
LPs who didn’t invest in us from the outset exactly what we’d do,
and continued to communicate with them as we did it. And guess
what — we did it and several came in and invested later in the year
towards our $50m final close. Do not underestimate the power of doing
what you say you’re going to do; follow through is simply
intoxicating (and unusual).
Fund II: Harden the model and move towards your optimal investing approach

Fund IIs can be scary. While raising Fund I is hard as hell and getting in business is awesome,
closing what is invariably a larger Fund II can lead to feelings like: “Am I really good at this?
What if I actually stink — I haven’t proven sh*t yet? How am I going to deploy all this money
intelligently? How should my strategy change now that I’m bigger? Do I need to expand the
team? How might this impact firm chemistry?” While some might think raising Fund II
deserves a victory lap, it is perhaps the scariest time of building a seed stage firm. Bottom
line is that this is generally being raised within two years of Fund I’s closing, as most
managers get out “hot” to be in-market for deal flow purposes and for testing out their
hypotheses around business model and investment approach. So unless lightening strikes,
there is precious little that has been learned about Fund I’s true potential. If Fund I was
raised entirely from individuals and family offices, then institutional LPs will be investing in
Fund II largely because you did what you say you were going to do, what you said you were
going to do was compelling, the team functioned well and firm reputation is strong. They
also know that if you end up being very successful and if they treat you poorly now that the
likelihood of their getting in later is low. So if you’ve done a good job with Fund I, you might
be pleasantly surprised by how much demand you have from quality institutional LPs.

Fund II planning at IA was sort of nerve-wracking, as we grew fund

size from $50m to $105m. We started investing out of Fund II in
February 2012. While we felt we’d be able to run our concentrated
approach even better, by growing our first check from $750k to $1-$2m
with a stretch of $3m, we still maintained our high net cash-on-cash
objectives which meant the value of our exits had to expand by 2x
assuming constant ownership. Gulp! This was the scary part. The cool
part is that by investing heavily in building high quality
institutional relationships prior to and during our initial
investment period in Fund I, we had added several new top-flight
institutional LPs to our Fund II roster. Because we were pretty clear
on what we were looking for in our LP partners, we reaped the benefits
of clearly communicating both our strategy and our goals for LP
interaction for the prior 2 years, leading us to have a very smooth
and low stress Fund II fund raise. But make no mistake getting to
this point was not easy; it required a lot of work, a lot of intention
and hyper vigilance to get things over the finish line.

Fund III: Show evidence of Fund I’s return potential and the execution power of a great
long-term team

By Fund III, 5–6 years will have elapsed since you first got in business. Even if you are a very
early seed stage investor (as we were and are), there will be a lot to show about which
companies have big-time breakout potential. Even if you have yet to secure a material exit,
sophisticated investors know how long it takes to build a great company and to get liquid,
even if you are open to using secondary sales. But by now there aren’t really any excuses;
you’ve either demonstrated skill at both team-picking and company building or you haven’t.
You’ve either established yourself as a widely respected seed stage firm and partnership or
you haven’t. And if the answers to any of these questions is no, then raising Fund III will be a
bear. But to be clear, if you’ve secured some high quality institutions in Funds I or II, they’ve
already done a ton of work to even invest in the first place so will be biased to continue the
relationship. That said, they’re also smart and commercial, and if they don’t believe they’ll
make good money over the long term they’ll have no trouble sharing the bad news and
ceasing future commitments.

At IA raising Fund III was a pretty easy affair; the LP group was
essentially the same as in Fund II. We ended up taking $160m and
started investing the fund in January 2016. This enabled us to add
some very early stage “hard science” companies as well as to lead
a few select early Series A rounds with $5m lead investments. While
we hadn’t had any scale exits yet, we had two sales that generated
substantial recycling (the sales of Simple to BBVA and ThinkNear
to Telenav generated over $20m, $3m of which went into the Series
B of The Trade Desk (TTD) that recently generated more than 22x),
and several high-potential companies that were largely proven (most
notably the aforementioned TTD). Equally as important, our
partnership was stable and had worked together over an extended
period of time. Brad, Jesse and I had been partners at that time
for almost 5 years, with Brad and I almost 7 years. We had long ago
decided that we wouldn’t hire any junior investment staff, with
each of us touching the bare metal and working closely with our
companies from the earliest days. This is still our model today.
LPs love consistency and team stability, and, quite frankly, so do
we.

I’m pretty opinionated about this stuff, as I am with principles of money management,
running concentrated portfolios and stripping very early stage venture down to its essential
elements. This is the playbook that worked for us. Best of luck.