Your new investor is a startup Founder too.

The last 5-7 years in venture have been transformative. Democratization of the industry has resulted in many first-time founders—Investors and Founders—on both sides of the marketplace. In the long term this will benefit the venture ecosystem tremendously by boosting innovation and global return on capital. However, the transitory pain resulting from the chaos of new entrants in a market can be difficult to navigate.

In this letter, I want to help Founders understand some of the challenging realities of their emerging manager counterparts with the hope to help establish stronger alignment and collaboration between the two groups. 

The philosophy

Most investors backing companies in new market segments or in newer forms of investment mandates are also recent Founders of their ventures. They face similar risks, experience the same learning curve, and are navigating the same brutal emotional curve as the Founders they are backing. To Founders, embracing this reality can help to establish and deepen valuable bonds with their investors. Strong ecosystems of tomorrow will depend on new entrants working together intimately to solidify alliances that challenge entrenched incumbents with effectiveness.

The main challenges new managers face fall into three main buckets:

Cash resources

Capital budgeting: Many new funds start deploying capital after the first close. When an investor is unable to raise the full fund, s/he must make capital budgeting adjustments that limit the ability to invest in future rounds of existing portfolio companies even where strong interest was previously communicated.
Operating budget: Portfolio companies with improved prospects can call on investors for additional capital. Funds don’t have this option. Their revenue is fixed—management fees—until they have exits or a new fund. This limits the ability to invest to keep up with scale.
Syndicates: Many emerging fund managers are still building their capacity to mobilize large investment syndicates around their portfolio companies. And when they ask, “who else is investing.”—they are not engaging in herd mentality, but attempting to assess syndication risk.

Knowledge and systems

Operating systems: At Fairbridge, we saw ~500 opportunities in our first year. And with a modest setup of Office tools and brute force we stayed on top of things. Today, our opportunity set is 8x. It’s physically impossible to handle this level of scale manually and important things fell through the cracks. Fortunately, we are now investing in a Practice Management System.
Fund operations: While they are adept at investing, many emerging managers don’t have experience in business operations. Learning operations is crucial, but it directs mindshare and time away from serving portfolio companies.
Theses: An investor’s view of the world can change as they navigate their business’ product-market-fit. This can result in changes in investment focus that impact the existing portfolio.

Human nature

It’s hard to say no: It’s difficult to turn down a founder. Investors can drag decisions because of bias and communication shortcomings on anticipated capital closes or investment committee processes.
The burden of “other” mandates: Investors with restrictive mandates might get caught up navigating the gray areas of balancing integrity among conflicting variables.
Founder emotions: Startups are incredibly difficult. They are emotional and personal. Personal challenges, moods, and pressures can impact investment processes for emerging managers.

Advocating for mutual conviction

Shared risk: Emerging managers face the same startup risks as Founders—tight budgets, reneged LP commitments, bad hires, burnout, doubt, and product-market-fit. Founders capable of engaging with their investor’s unique reality can derive tremendous benefit. For example, one of our CEOs introduced us to an LP, which unlocked investment in the company’s new financing after a brief delay.

A mutual bet: There’s a unique opportunity for new entrants in the venture ecosystem to boost return and Founders play a pivotal role. Founders should remember that their potential investor is also startup Founder, navigating similarly difficult terrain. Founders then need to perform due diligence on their potential investors to answer the question: “Is this a Founder I want to invest in. Is this someone I can trust with my vision, someone I can grow together with?” Mutual conviction is at center of establishing trust and strategic alignment required to build enduring ventures and these are especially critical when the chips are down.