What is the right VC fund strategy?
DRIVING FUND ALPHA
GPs may have multiple strengths by nature, but every VC fund should master one specific alpha strategy depending on the fund size and fund generation — everything else is tactics and execution. Strategies may change over time, mainly due to the fact that the startup-vc-ecosystem is a fast-moving hyper-agile rocket ship.
There is a GP innovation dilemma though, which forces funds to re-evaluate and change their alpha strategy from time to time, mainly driven by market dynamics, the competitive fund landscape and of course increasing AUMs. So why is this important? Well, your alpha strategy is the key to either successful fundraising or a stellar dealflow and outsized fund returns.
If you just invest randomly along the power law distribution curve, you might be successful (or not) over short periods of time. Over a longer term mediocrity will kick in and your performance will regress to the mean — let’s be fair no fund wants to be average after all.
I mapped five driving alpha strategies for VC funds and put them into a context of their fund size and fund generation. Some can even be combined with each other.
i. The Sourcing Wizard Strategy | Network & Reputation
GPs may go after sourcing strategy perfection, alongside their investment focus. This is mainly driven by outstanding hyperlocal networks, a persistent geographical advantage and a high-flyer fund reputation. GPs can rescale distributions throughout a sophisticated and well-tailored sourcing strategy.
Fishing in a better pond makes all the difference in the world and will eventually lead to higher expected returns compared to average funds. In my opinion the sourcing strategy works best for 1st time and emerging funds, unattached to the fund size — serial funds kind of have this magic power by default, as they eventually build it over time.
ii. The Unique Niche Strategy | Knowledge & Expertise
A unique niche strategy is mostly driven by GPs with a specific domain expertise or a particular knowledge in a vertical, business model or any industry. This magic power will help GPs not only within the sourcing process, but as well in the deal winning against bigger serial funds.
This can be a powerful edge, especially in the early-stage segment as pre-seed and seed startups rather look for hands-on and highly specialized VCs over „just” money. This particular strategy works best for small 1st time and emerging funds, as it’s hard to deploy massive volumes into high quality deals in niche markets or verticals.
iii. Fomo Hype Strategy | Opportunity & Dynamics
The fomo hype strategy is more real than ever. Just look at all the web3, metaverse and crypto funds popping up everywhere like mushrooms — fully loaded with cash and ready to shoot. This kind of strategy is a serious bet based on conviction that a certain hype turns into a sustainable and long-term play — keep in mind not all hypes and short-term trends stick around.
Interestingly this kind of strategy applies to 1st time, emerging and serial funds of all fund sizes. This kind of strategy works best in combination with the sourcing wizard strategy and / or the unique niche strategy, as trending topics become crowded quickly — therefore you might need to build an extra edge on top.
iv. Platform Play Strategy | Add Value & Innovation
It seems very apparent that platform and innovation plays make most sense for late emerging and serial funds with a certain fund size and higher AUMs, due to the fact that GPs need money and resources to build and operate platforms, which add a significant value to portfolio companies.
Platform and innovation plays can be a beautiful long-term unfair advantage, either they serve portfolio companies (e.g. recruitment, marketing, partnerships, sale, operations, and board support) or they are used to improve end-to-end fund operations — from dealflow over research to network infused portfolio management.
v. Invest Better Strategy | Judgement & Thesis
If you bundle excellent judgement, a bold out of the box investment thesis in combination with a unique deal access you can derive an outstanding invest better strategy, which will let GPs pick better deals further up the power law distribution curve. The overall goal is to achieve outsized results especially in early stage (as in late stage the crucial aspect is and will be access, because targets are visible), the strategy does not only cover entry investments which are only half of the equation, but as well the right follow-ons.
Picking better further up the curve goes hand in hand with strong research and insights, therefore it works best with a strong AI/ML knowledge or prediction platform play. This kind of strategy does not necessarily drive alpha at all times, but it surely reduces beta for sure. Due to the specific skillset, experience and judgement capabilities this strategy makes most sense for late emerging and serial funds across all fund sizes.
So is there a golden rule or a one-fits-all strategy?
No, of course not — that would be way too easy. It all comes down to the GP team, the underlaying investment thesis, fund seniority and of course the fund size. Merging all facets into a consistent master strategy is an art for itself. But keep in mind even the best fund strategy in the world is worthless, if you don’t have the right GP squad to execute upon it!
Any thoughts or questions? Reach out!
I am a passionate and hands-on venture capitalist, serial entrepreneur, emerging fund advisor and active angel investor via @MinimalVC. After 10 years of flying over 1.000.000 miles, spending 1.200 hours on airplanes, looking at +1.000 start-up pitches on all continents, I decided to gather some of my thoughts based on this extremely rewarding professional journey. Reach out and get connected!