Underdogs and VC-Market-Fit

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I enjoy learning the game of an industry and feel lucky to keep deepening my knowledge of the VC game since starting Spice Capital.

I came across this video and wanted to add additional context as someone constantly assessing GP-market fit myself.

Quick definitions → GP = General Partner (the head of a Venture Capital Fund), LP = Limited Partner (the investors in a Venture Capital Fund)

Here’s the video - an interview with Jason Calacanis and Jamie Rhode - Partner at Screendoor - an amazing fund-of-funds that has backed many strong emerging managers with true anchor checks and mentorship with some of the best seed investors in the game (shout-out Hunter Walk and Satya Patel)

Here are my thoughts on the podcast.

Topic: Diversification and Follow-On

They bring up diversification at the early stage. Apparently Jason invested in 100 startups in his fund 1 and rocked with 4 unicorns - Robinhood, Superhuman, Calm, Density. He beat the odds. Statistically only 2% of companies become unicorns. That’s 2 in 100 or 1 in 50. Agree with diversification. I am of the belief that it is better to have more “shots on goal” at pre-seed. Angellist backed me up on this. Angellist’s Head of Data Science wrote a great report titled “Should Seed Investors Follow On?” here. We have 50 companies in Fund 1. Because I was building a brand as a new firm while investing in parallel - having the ability to do deals after you have been in market for a year is helpful ! Also, I learned so much from my early founders and those learnings informed my investment decisions in year 2 and 3 of Spice Fund I. 

Topic: Finding managers that are overlooked.

Screendoor is doing the lords work. Most fund LPs don’t want to sign up for an overlooked manager strategy (ironically that is the basis of Alpha. and another tangent - the legal name of my first fund is ‘Fund Alpha’ 🌶️ ). I was told today that institutional LPs running emerging manager programs prefer spinouts from brand name VCs because its a “safe” bet. They won’t get in trouble for backing a spinout from Seqouia if the fund goes to 0, but they would get blowback if they picked a manager with no traditional VC experience who delivered subpar returns.

Yes - it is important to have managers from edges/tails/untapped layers that are overlooked. I fall into that category so I’m obviously biased. But I also recognize the challenges in doing so. One thing I didn’t know I needed before starting Spice was the approval of VCs up-market. With a small AUM (like most emerging fund managers have), you don’t have the unlimited funds to support founders in subsequent rounds - you have to rely on other VCs.. and if you truly are investing in the edges, in net-new categories…then you see where I’m going with this point. The ‘category’ doesn’t even exist yet which means there may not be follow-on capital who shares your POV.

EX: before Coinbase’s success, there weren’t many growth stage crypto funds and frankly - there still aren’t that many today (even though crypto has a $2.4Trillion market cap).

Additionally, venture is relatively new and recently democratized. There aren’t too many non-traditional VCs that have “made it” yet. Not many emerging managers outside of traditional Silicon Valley stereotypes are sitting on large funds and long track records. I don’t have a good solution for this besides waiting- the best bet is to hope bigger funds come around once the financial metrics are indisputable.

(EX: I saw this happen first hand with Beehiiv..creator economy fell out of favor with VCs - Beehiiv executed brilliantly and swept up market share…of course now VCs want in - but they missed the 1000% return already)

GPs - if you claim to be early-stage investor, you should probably be invested before the category is part of the zeitgeist.

LPs - if you continue to pattern match for the same types of GPs you did 30 years ago, you probably won’t be generating much alpha.

Topic: Investable Categories

Jason talks about the issues with some of the DEI funds who backed low-margin categories.

Therein lies the issue. I think there is a big bias in Silicon Valley against these specific categories at any given time. In general, Silicon Valley gets away with creating stamps of approval on “investable categories” every 6 -12 months. Tech twitter propagates the groupthink and every other category falls out of favor. Narrative cycles are normal and ok - but it hurts those on the fringe who need access to capital for net-new ideas.

EX: Uber and Airbnb are both marketplace businesses…but today an AI startup would be funded faster than a new marketplace business.

Let’s give the example of bias against CPG - I’m not disputing that CPG is lower margin than software, but the exits are bigger and and more frequent than you expect. I talk about this alot with my founders but it hasn’t resonated with VCs in the same way. I think partially because they aren’t aware at how much TikTok/Reels can move product and how low the CAC has become if a brand knows how to use these platforms.

This may be why CPG is on absolute fire.

In beauty alone - “Gen Z demographic is responsible for one-third increase in facial product sales from January to June of 2023” -Nielsen IQ.

Other recent Unicorns in CPG:

• Selena Gomez’s Rare Beauty (launched 2020) is looking for an acquisition at $1B dollar price tag.

• Liquid Death (launched in 2018) raised at a 1.4B valuation - clocking $263 million in retail sales in 2023

• Skims, founded by Jens Grede and Kim Kardashian(launched in 2019) is valued at $4B and was profitable after their first drop.

The main IPOs in the “bear market” were consumer companies. This seems LP-friendly to me, every VC fund blog post I read talks about DPI.

Why does this matter? The forcing function of being an overlooked founder by the VC industry is that you have to get to profitability faster.

Stats from my Fund I - across my 50 portfolio companies, the female founders raised less capital than their male counterparts (sad but not surprising), but were first to start generating revenue (across every industry). They didn’t have a choice.

If you are an underdog, you will probably raise less money in the early days (EX: I’ve rarely seen CPG brands raising 5 years of runway in a seed round the way I’ve seen software companies do it).

This necessitates more frequent fundraising efforts. A constant “reckoning” of the business - for every subsequent financing, the investors must look under the hood to reevaluate business fundamentals. There’s no room for error -the underdog will fail fast.

I would bet that undervalued founders welcome an IPO. They are used to being scrutinized. The underdog has never had the luxury of raising capital on narrative - they are ready to be measured on metrics.

Notes:

1. All of my takes are specifically targeted around pre-seed/seed stage rounds. I can’t speak to later stage/growth because Spice is focused on early-stage investing and has small funds.

2. You should read Michael Dempsey’s post on Narrative Cycles