How to Leverage Micro VC Funds to Build an Angel Portfolio
Friendly funds can be your... friend.
Fund investing, like adulting, is boring.
That’s the first thing anyone trying to raise a fund needs to understand, as well as anyone thinking about investing in one. The partner at the fund, the VC, gets to do the fun part—the meeting with founders, vetting deals, negotiating, helping, etc.
You get, if you’re lucky, a Powerpoint and some financials once a quarter.
So what’s the point?
Fund investing can be additive to your angel investing and there are two main arguments for it:
Getting indirect benefits from being invested in one or more funds.
Having a better overall portfolio of venture capital by adding funds into the mix.
Ideally, a small fund could get you the following, but you have to ask to make sure it’s available:
Co-investing opportunities. Are investors allowed to come into deals that the fund does side by side with the fund? This creates a source of deal flow for investors who aren’t out there full time creating opportunities. If you’re not showing up at all the events, putting out content, constantly networking, generating enough deal flow—more specifically enough high-quality deal flow—being able to co-invest next to experienced professionals can really boost your funnel. That being said, some funds charge extra fees on top of these opportunities—fees that might, in the long run, actually be costlier than the investments through the fund itself. Brooklyn Bridge Ventures doesn’t, but it’s pretty common that a fund might create an SPV for its co-invest opportunities and charge fees for it.
Access to the partner. If you’ve put money into a fund, I think it’s reasonable to expect that partner to check out the deal flow that you find on your own, and let you know what they think. In a way, that’s like having a free analyst at your disposal. Depending on the minimum investment size, if you think about what hiring an actual analyst, or someone more senior, might cost you to look at deals you’re serious about, an investment in a fund could may for itself in access. This is above and beyond whatever events and educational opportunities the fund provides for its community, which could also be very useful.
Access to other investors. By being in a pool of other fund investors, the LP meetings and co-investment calls could be an opportunity to connect with other like-minded or like-situationed investors—but again, it depends on how a fund organizes its community.
Finance 101 would tell you that, in the public market, you want to be in at least 20-30 names to eliminate a good chunk of the risk (as defined by the standard deviation of return) that you don’t actually get paid for. However, the private markets are very different—with the returns being much more positively skewed towards a smaller number of bigger winners. The point is that the number of angel investments that you would need to hold to significantly increase your chance at finding those 1-2 deals that really make the whole thing work is probably more than you have the bandwidth to make.
In fact, that number is probably even more than the average VC fund has the bandwidth to make. That’s why it might be worth not just being in one fund, but in several.
Consider the following two portfolios:
You have $500,000 that you want to put to work in venture capital over the next three years. You could be in it just for the return, but perhaps you’re looking to build out a track record in the vein of potentially opening up your own fund one day.
You could do either of the following, for simplicity’s sake:
Option #1: Do 100% angel investing.
Option #2 Do 50/50 angel investing and fund investing.
If you do 100% true angel investing, where you’re putting money directly into companies, and not other people’s funds or syndicates, you have to ask yourself the question of how likely it is that you’ll see enough good deal flow to find the big winners.
One way to measure that is to imagine the theoretical $500-$1mm angel round that a founder is looking to raise. The question is why you would get tapped for this opportunity.
a) Write a big enough check where it would make sense for a founder to spend time with you—and for other founders to make introductions to you knowing that your check size could take up enough of this round?
What check size is that? Imagine someone trying to raise this round by doing a bunch of lunches. If you spend an hour with someone over lunch, and said yes, what check size would make it worth it, knowing that most of the lunches probably wouldn’t result in a yes. If you wrote $25k checks, that would mean that the founder would need to take 20-40 lunches just to get the yeses alone, not to mention probably 2-3x that in total because a lot of people are going to say no.
So, while $25k isn’t a small amount of money, that probably means you’ll need a connection or something else to get into deals directly with that check size.
We’re not talking about syndicates here, which would mean you’re paying a layer of carry and relying on other people’s deal flow, which is pretty much like fund investing. In fact, those deals are actually set up as mini-funds. Syndicates are fine, but they’re not going to prove your track record in any way—because not all the best deals wind up having available syndicates.
Plus, getting into someone’s syndicate with a small check doesn’t prove you can lead or co-lead a round on behalf of a fund should they hire you, if that’s your goal.
So, realistically, for your money alone and the size of your checks to talk in the best deals, we’re talking about writing $50k checks, if not more. Less than that and you need something else to bring to the table.
b) Reputation for adding value. I’m sure you’re very smart and very experienced. So is everyone else. For your resume to make you a desirable addition to a cap table, not only does it need to stand out, but people need to know about it. If you’re an early investor in other things that people know about, or an early employee of a company everyone knows this really helps people seek you out to be included. It helps them write the press release for their round:
“Backed by early investors in Plaid, Slack, and Flatiron Health, as well as some of the first employees at Facebook.”
If you’re counting on your expertise, then people have to know about it. You could be super knowledgeable about the fintech space, because you’re looking at it for Goldman Sachs, but a lot of people work for Goldman. If you lead fintech investing for Goldman, that’s something, but if you’re a VP there in a sea of other VPs, you’re going to need a newsletter, social following, or somehow be on the radar of today’s founders for them to seek you out in a deal with your smaller check size.
Ok, so maybe you’re getting away with your $25k check size because you’re awesome—but that means you’ve still only got 20 deals to work with to find that unicorn. That’s pretty hard—especially if you’re not doing this full time. You’re spending less time in the market, less time building your profile, etc.
But maybe you could do it?
What if you added funds to the mix?
Funds that are $10mm or less are allowed to have 249 beneficial owners in them—which means that they could conceivably take check sizes of $50k. They’d undoubtedly take $100k. Those checks will probably wind up in 30 or more deals over the next 3-4 deals.
Funds that are larger are only allowed 99 investors, so their minimum check sizes will be larger. They could be looking for commitments that are closer to $250k or more—but the benefits still apply if you’re looking to put more money to work. Family offices could and should take advantage of mixing in funds to leverage their direct investments.
If you made five commitments of $50k to five very early stage microfunds, you’d be putting half of your money to work and getting an underlying portfolio of upwards of 150 deals vetted by full time professionals. This significantly increases the chance that you’ve got some big ones in there somewhere.
Plus, you’ve still got $250k leftover—to place into 10 companies, three or so per year—which is probably a more realistic pace for most people anyway. These ten companies could be sourced from the flow coming from these microfunds, so it’s probably better than what you’re doing on your own. Even if you’re sourcing on your own, you’ve not only got five people to pass your deals in front of, but now you’ve leveraged your own check since one or more of theses funds might want to get involved, too. That makes you a more valuable investor to founders, if you’ve got these kinds of connections to early stage funds.
On top of that, if these funds have good co-invest policies, they might allow you to come in side by side with them for $10k into some of these deals. There have been many times at Brooklyn Bridge Ventures where I’m leading a deal and after our co-invest call, an LP wants to put in just $10k. Founders usually allow it because I’m already coming in with a lead check and they didn’t have to do much work to get these little side checks in on top of that. If you could make this happen with some quick co-invest decisions, now you could be doing upwards of 25 deals with your remaining capital and getting some more shots on goal.
Of course, some funds will just take your money, not answer your e-mails ever again, and not let you into any deals they do—so you really need to do your homework. When you can find small, friendly funds, they can open up a lot of opportunities for you as an angel investor.
this is a very thoughtful post-and excellent. People underestimate the amount of work and time it takes to create good deal flow let alone great deal flow. This post also ignores ancillary costs like legal. If you don't do the legal right in the beginning, you won't have access to the deal if it gets hot even though you are on the cap table.
Excellent post. I’ve invest in over 100 startups and 25 funds over the past 2.5 decades. Have gotten some great co-investments through the funds and also allowed to diversify across stages and sectors.