At present, one needs to be wealthy to raise a new venture fund. This is an unnecessary structural barrier that materially limits the opportunity for new GPs, new funds, new perspective and new opportunity. With resulting downstream effects of less funding to underrepresented minorities.
Taking time to reflect upon the structural barriers in venture capital, I’ve thought of my own career progression into this ecosystem. It has struck me that many inherent privileges, including the financial success I have accrued through my professional endeavors, have enabled me entry into the world of venture investing. And it concerns me that we’re limiting our capacity for a diverse, equitable and inclusive industry based on a set of expectations and criteria that is likely not an indicator for potential success. This piece shares my reflection on my journey to venture and posing a series of questions for venture fund Limited Partners and General Partners to consider.
I’ve been investing for the last 8 years and in March launched Argon Ventures, a new deep tech pre-seed fund that I co-founded with my friend and colleague Andy Feinberg. This is my second fund, the first being with Project 11 Ventures back in 2014. I learned the basics of venture and broadened my network through my time volunteering and investing out of Techstars Boston and via a personal angel portfolio.
I didn’t start my career with a plan to become a General Partner for a venture fund, but I’m a big believer in the socio-economic benefits of entrepreneurship and the vitality startups can bring to new and old industries. So in 2012, I was looking back at my career in tech and noted with pride that I had a hand in creating a few hundred new jobs through my two previous startups. But I asked myself If I wanted to have an order of magnitude greater impact, what would be the best approach?
Starting as a mentor at Techstars, I began to think about how I could help founders build their own businesses, which had the potential to spark a chain reaction of more founders, more talent, more high growth businesses and hopefully greater societal benefit. And after a short while, I also found my time working with founders and investing in startups to be intellectually and energetically enjoyable.
I have come to venture from a platform of privilege.
In a “former life,” prior to becoming a VC, I was a software engineer, founder and CTO for two Boston-based enterprise software companies — from initial team formation, product concept, growth and two successful IPOs. I’m mindful that I am a healthy, straight, white American male, born in 1972 whose father and mother created opportunities for me to enhance and develop my computer talent. By the time I graduated college, the Internet was poised to change the world.
That’s not to say life was without a few obstacles, I came to this journey coming from a mostly lower middle class household, my father passed away in high school and he was on disability, due to Multiple Sclerosis, for most of my childhood. Because of generous scholarships, I had the opportunity to graduate from Worcester Polytechnic Institute. And then serendipity arrived, and my first job out of college was a startup which triggered my own chain reaction to the present day.
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Over the first 20 years of my career, building and founding companies, I came into unexpected financial success. Wealth provides freedom. The freedom to be intentional with life choices and to take risk to create more opportunity.
In many ways, this form of financial freedom is currently a prerequisite to become a venture capitalist.
Biases and closed networks have led to a dearth of diverse GPs joining and advancing venture careers within established funds. So if someone sees that it’s unlikely they will become a partner at a venture fund, perhaps they’ll consider creating a new fund… But it’s my conjecture that many qualified, high potentials GPs don’t have the wealth to make this personal career investment, which I assert is an unnecessary structural impediment to building out a diverse GP ecosystem.
I first had to accumulate and then deploy a significant amount of personal wealth to build a track record and network to build a proper foundation in venture. There was also a significant opportunity cost, by not taking a salary, over several years, so I could gather experience and prove my potential. And then, to take on the role of General Partner, there’s a “GP Fund Commitment” in the hundreds of thousands and for a large fund sometimes millions of dollars.
We know that systematically underrepresented minorities do not accumulate as much wealth as white males. As researched by the Urban-Brookings Tax Policy Center, the median value of family net worth for White Non-Hispanics is $171,000. For a Black, African-American Non-Hispanic, Latino or Hispanic, family net worth is essentially 10x lower at $17K to $20K (as reported in 2016). This lack of foundational wealth likely permeates even to those minorities who graduate from top tier colleges, work at startups or start careers as Associates and Principals at venture capital firms.
So I pose the question, are the current expectations for “General Partner Wealth” a core factor in limiting the diversity of fund managers?
I believe we need to consider alternative paths so high potential GPs can build an investment track record and we need LPs to publicly renounce GP fund commitments requirements.
There are many ways to break the cycle that I am not including here — not because they are not worthy, but rather in order to focus on one piece of the puzzle. Namely, does an implied expectation for wealth artificially limit who can become a GP?
Certainly, for example, VCs investing in startups founded by diverse entrepreneurs, and LP insistence that GPs do so, are additional, worthy ways of trying to empower underrepresented founders who, with success, could then have better opportunities to follow more traditional paths to becoming GPs themselves. Established venture funds must focus their hiring practices and talent development to be more inclusive. There are many parallel efforts that we must all push forward together.
First, I’d like to point out the potential flaw in expected GP fund commitments. Limited Partner fund investors want GPs to have “skin in the game” so there is “alignment” between all parties. e.g. One will seemingly make better investment decisions if you are also investing a substantial amount of your own money. I understand the motivation of this requirement, but it seems flawed.
As VCs, we don’t have an expectation that a startup CEO needs to invest a significant amount of their personal capital before we fund their company. We also insist founders be paid a good wage so they are not under financial duress. We evaluate their character to ascertain if they will push hard with every fiber of their being to build a successful company, which then hopefully results in mutual financial success. We look for indicators of evidence to project their potential to grow as executives and industry thought leaders. We understand there is long term alignment because of shared upside.
It has been shared with me that LPs’ market expectations on GP commitment might differ strongly from the private discussions with any particular new fund. They may even consider a management fee offset, which allows the fund manager to make a larger GP commit than they could otherwise do out of personal liquidity. It’s nice to have flexibility in a particular circumstance, but the public perception is problematic, and is even enshrined in the Institutional Limited Partner Association’s set of core Principles (page 17):
“The GP should have a substantial equity interest in the fund. The GP commitment should be contributed in cash as opposed to contributed through the waiver of management fees or via specialized financing facilities.”
A Google search also sets the expectations for large GP commitments, from a minimum of 1% to over 2% of a fund size.
“GP commitment is typically in the low single digits… Even at moderate fund sizes these low single digit percentages can add up quickly. In the past, the GP commitment for most funds was in the 1%+ range. So, for example, with a $100M fund, the GPs would be expected to contribute $1M. If you have four GPs on a fund of that size, the capital commitment works out to $250K for each GP. For a new venture firm with young GPs, that might represent a significant amount of their personal investable assets.”
Source “Dividing the Pie: How Venture Fund Economics Work”
When we collectively talk about a $10M invested in a startup, when we read about the next Unicorn $1B+ financing, it may seem like $250,000 isn’t a lot of money. But let’s be clear and succinct, that’s actually a substantial sum of personal capital! Even for a “small” $20M fund, a 2% commitment with two GPs is still a $200K commitment for each partner. These capital requirements are out of reach of many who would otherwise be highly qualified as a General Partner.
If LPs won’t change their attitude, perhaps this a realm where GPs can step up. Many GPs are very generous by making LP commitments to new funds. I’ve been a direct beneficiary of this supportive spirit. I’m fortunate to be able to rely upon a number of amazing VCs as key mentors to build my venture career. So instead of considering an LP commitment, maybe GPs should consider a collective mechanism to fund the “startup costs” and GP commitments for a new fund manager.
Finally, I’d like to call out for greater collaboration and new program development to empower more proto-VCs to build track records. Rightly so, fund investors want a new GP to have some experience; to demonstrate their ability to source and win high quality deals; to have impact with founders.
Increasingly there are new ways to build a track record without first coming into wealth and becoming a direct angel investor. An easy first step is to #GiveFirst as a mentor via Techstars or other startup programs. New programs like Spearhead, led by Accomplice Ventures, provide both capital, structured learning and a community. XFactor, a venture fund led by women investment partners, was originally built upon the platform from Flybridge Capital Partners. AngelList’s Rolling Venture Funds could become a platform to activate diverse, first time fund managers. And larger, established funds need to be more aggressive in building out Scout programs to be more inclusive.
But I’ll bring this back to the LPs, who have the most vested interest in nurturing the next generation of fund managers. We need more institutional funds that will back first time fund managers in creative new models.
When investing in a startup, as GPs, we manage risk through incremental capitalization. e.g. First round of less than $1M, build some evidence of execution, raise subsequent rounds. We leverage protective provisions and define rights like pro rata to establish guarantees to invest further capital as a reward for our earlier risk taking. Are there similar constructs that could be applied to earlier, smaller LP fund commitments?
LPs should reconsider how to evaluate a General Partner’s “commitment” and financial alignment. I hope to see more LPs lead at the “pre-seed” of fund formation, similar to how many GPs, myself included, will back first time founders. And taking the long view, I believe institutional fund investors will be financially rewarded by elevating their leadership and creating new platforms that activate a next generation of diverse fund managers who will bring new points of view, novel investment opportunities and broader financial success.=
Regardless of the form, we need to remove the structural barriers and wealth expectations of new fund managers so we can expand the talent GP pipeline beyond those like myself who are privileged and wealthy.
Thank you for the review and feedback by Jason Allen (MassVentures), Jeff Bussgang (Flybridge), Jeff Fagnan (Accomplice VC), Andy Feinberg (Argon Ventures) and Jody Rose (President of the New England Venture Capital Association and co-founder of Hack.Diversity)
This piece originally appeared on Noteworthy, and was republished here with permission.
