What makes a VC fund "Tier 1"?
#23 | On why brand is so important in VC
Not much to add here. I’ve asked this question to myself many times, and I think I came to an answer
My buddy Chris edited this edition of Unbeatean Path in Vilnius while listening to software engineers explaining how they are building the next-generation of defense drones
Venture capital is a long game, but it's also highly opaque, and the two are actually connected.
Being a long game, it takes time between investments and cold money in the pockets. During this time, venture often resembles a Ponzi scheme: as long as someone invests at a higher valuation, you mark up your position and pat yourself on the back while admiring your TVPI. You literally have no incentive to mark that position down, unless there is some hard signal that you must do it - a.k.a. down round.
As a result, it takes a long time before a bad fund is actually recognized as a bad fund.
Startups raise money every 18 months, and every 18 months they must face the market and its judgement: sometimes they manage to increase their valuation even without proper traction but, more often, their valuation will take a hit (or they won’t raise) without results to show. VCs, on the other hand, raise funds every 4 years and often have markups on paper to show as a promise of future performances. This means it will take at least a couple of cycles of fundraising for the fund to change its reputation.
Just to be clear, this is not a criticism of the system – it’s the way VC works – and good portfolios take time to mature before they show results. However, an undeniable consequence is that the “quality” of a fund is not simple to assess before almost a decade has passed.
Moreover, even if startups or other fund managers wanted to assess the quality of a fund that's old enough to have a mature portfolio, it would be very hard, as their performances are not public (except for rare examples like the great team at Unruly).
The closest proxy for performance we have is their portfolio. One could theoretically look at a fund’s portfolio, look at when they invested in each company, make an assumption about ticket size and valuation, and make an educated guess.
This is certainly better than nothing, but anyone who has spent some time in venture knows that logos on websites never tell the whole story, and there are just too many variables that could change the estimation substantially.
Take this example:
The firm says it has achieved 17 exits so far, the largest of which came from speedy grocery giant Getir. Revo first backed the company in 2017 and then cashed out in a secondary sale at the height of the speedy grocery boom in 2021, when Getir was valued at $7.5bn. The firm did not disclose the size of the stake it sold but Sifted understands it comfortably returned the value of the firm’s first fund. The VC offloaded its Getir stake at an opportune time. By 2023, Getir’s valuation had fallen to $2.5bn, and last year it withdrew from all markets outside of Turkey.
If you are the Turkish VC Revo, you are very proud to have Getir on your website. However, you have to specify that you sold when the company was valued at $7.5bn, because now it is valued at $2.5bn - one-third of that. But what if you are Tiger, who invested in the startup during their Series C at $2.6bn?
Moreover, as Sifted notes, the size of the stake matters.
According to Dealroom, Revo invested in Getir’s $38M Series A. Take the hypothetical case in which the Series A valuation was $150M and imagine the round was oversubscribed and there was only $500k of allocation left: that investment of $500k at $150M would have been worth $25M at the home run valuation of $7.5bn, which is unfortunately only a quarter of Revo’s $100M fund.
On the same theme, there are several examples of sub-$1bn exits that return funds multiple times because of the entry valuation, cash efficiency of the business, and fund size.
The main question I am trying to answer with this long preamble is: what makes a VC fund “Tier 1”?
If you can’t assess the performances of funds based on real data, it takes time for portfolios to reach maturity, and the conditions when one deal was made are so important - how can certain funds be widely recognized as better than others? why is it that some of these funds give strong signals to the market whenever they invest? why are some funds “Tier 1”?
Frankly, I think venture is a brand game
Taavet Hinrikus from Plural at 20VC
And, frankly, I agree.
My thesis is that in most cases, the brand comes first and the fund’s performances follow - not the other way around. And there is nothing wrong with it.
If you are a returning reader of my work, you know how much emphasis I put on the importance of storytelling. I believe that storytelling is a self-fulfilling prophecy, and, as such, building a strong and credible brand around yourself is enough to convince people to think you know what you are doing. Once people think you know what you are doing, they follow your guidance; the best investors want to invest with you, and the best founders want to work with you.
If you manage to put yourself into this positive cycle, you carve your spot in the industry, and the rest comes.
Don't get me wrong; there is much more to venture than sourcing - after sourcing you have to select the best deals, secure your spot, and support the founders as much as you can.
But I think the 4-S of venture follow each other in a precise order, and as in sales you will fail if the top of your funnel is low quality, also in venture it all starts from seeing the best startups first. Without seeing the best, you could be amazing at selecting, but you would still fail – the power law is reckless, and selecting the best among mediocrity doesn't move the needle.
Can someone have the “magic touch” for sourcing? A secret sauce to succeed?
Maybe back when Warren Buffett was counting tank cars in rail yards, yes. But in the era of data-driven strategies, AI has leveled the playing field, and secret sauces don't exist.
It's not by chance that most of the emerging managers these days are very similar on this front: all of them have spent time building an audience, all of them share their thoughts in long or short form, and use their brand as a competitive edge.
In most cases, the audience comes first, and investing is almost a byproduct - a way to monetize the work done to build a following.
I think VC has always been a brand game - both Paul Graham and Fred Wilson started writing in 2003 - but for a long time there was another way of doing things, a more traditional way.
I don’t think the traditional way works anymore.
thinking out loud separates those who live and breathe their thesis from those who simply make slides
great and sharp insights. Thanks!