There are some venture capitalists who consider themselves “entrepreneurial VCs” because they identify with and approach investing from an entrepreneur perspective. Others are actually former entrepreneurs who join a venture fund and call themselves a VC entrepreneur because they once walked in the shoes of an entrepreneur.
And there is another unique breed: One-time entrepreneurs who never invested in startups professionally, but who decide to start a fund as a new venture — a truly entrepreneur VC. I am one of them.
As a seed-stage VC, I am constantly telling entrepreneurs that they must bootstrap, stay lean, get to market quickly with an MVP, iterate to find product-market fit, figure out unit economics, raise institutional capital and finally start scaling.
But many wrongly believe that the most important step after “coming up with an idea” is to raise funds. They often lament that they are caught in a “Catch-22” between needing money to invest in the myriad things a company needs to get to market (salaries, customer acquisition, product development, etc.) and not getting going at all.
I wish I could tell them there is a single formula for getting around the Catch-22. There isn’t. However, not everyone is cut out to be an entrepreneur — it is an honor reserved for the most resourceful and irrational among us. So, by definition, entrepreneurs are supposed to be magicians who break the Catch-22. Not investors.
Not everyone is cut out to be an entrepreneur — it is an honor reserved for the most resourceful and irrational among us.
Three years ago, my partner, Erik Rannala, and I set out to create an “entrepreneurial” seed-stage venture capital firm in Los Angeles. At the time, many of the dot-com-era funds were barely investing in LA anymore, and the volume of new venture creation had yet to really recover from the dot-com crash of 10 years prior.
As a believer in the “lean” entrepreneurial spirit, I was committed to practicing what I preach. Entrepreneurs do not raise institutional capital until they achieve product-market fit, and nor should I. The problem is, by definition, venture funds invest capital. And to invest capital, you must have capital. Without it, how do you even create a venture fund, much less get to product-market fit? Much like the entrepreneurs we now advise, we were determined to overcome this Catch-22.
While there is no single formula for success, we opted to follow our own advice. Here’s how we did it, practicing the entrepreneurial formula we preach.
Hypothesis: Find the untapped market
In our view, LA harbored a vast untapped talent pool of great entrepreneurs who simply needed some guidance and exposure, and, in a very short time, could generate decent seed-stage deal flow. We were also confident that, given the lack of capital in LA, there was an opportunity for us to be the catalyst, to inject some early-stage funds that would produce great companies that could compete head to head with Silicon Valley startups for capital from Silicon Valley firms. Of course, we also aimed to personally materially impact the entire ecosystem, and do this not for just Mucker companies, but LA in general.
Bootstrap: The Catch-22
In order to launch a venture capital fund without capital, we had two options. One was to start out as small angel investors. But we knew this would immediately plummet us into a trap of lacking meaningful ownership in each company. This meant that even if we had good deal flow, we’d be unable to get into the same deals once we were ready to deploy more capital. (It’s easy to squeeze $25,000 into any round, but larger amounts, not so much.) We nixed that idea almost immediately.
Our second option was to launch an accelerator. With this approach, the primary investments would be expertise and time, not capital — and thankfully we have plenty of both. From the capital perspective, our very, very lean accelerator would only need about $600K to run a cohort. One can get that kind of money from their own back pockets, friends and family. Accelerators also have meaningful ownership in the companies in which they invest, generally 5 percent or so. And, because companies typically cannot participate in two accelerators at the same time (unlike a syndicated round of VC financing), we would be able to prove our ability to win/lead deals and exclusively work with entrepreneurs for a period of a time.
Of course, there are also pitfalls to using an accelerator as the MVP to a venture fund. The low investment-cost basis of an accelerator often prompts its partners to adopt a “spray and pray” approach to building a portfolio. There is nothing mathematically wrong with that from an ROI perspective, but it’s the exact opposite approach of the highest-performing venture funds.
For better or worse, the optimal return generating venture fund strategy and typical accelerator strategy are actually diametrically opposed. If we wanted to eventually scale up an accelerator into a proper fund, we would need to merge the two, using “traditional” venture investment filters and business models to pick only a few companies a year, and concentrate our time and effort to maximize the success rate of every single one of our investments. Essentially we would have to market ourselves as an “accelerator” while operating as a venture capital fund.
We got to market as fast and cheaply as we could. We wasted our own time before we wasted other people’s money. We ate our own dog food.
Finding MVP: The entrepreneurial way
It’s easy to see the direct parallels between typical entrepreneurial chutzpah and how we launched Mucker. Like any entrepreneur, we began by testing out our new idea to see how the market would react. We effectively created our version of a “landing page” and drove some traffic to it. We launched on October 2011. We had a website designed and built by some guy on oDesk who was using a $10/month shared hosting plan. We paid a few hundred dollars for a logo from 99designs. We begged a slew of much more important and accomplished people than we were to serve as mentors. I successfully pleaded a friend to do some PR for us.
We got lucky. We earned coverage from all the major tech news outlets, and received over 250 applications in a matter of weeks. Out of that first crop, nine really great entrepreneurial teams emerged that felt like a right fit, and off we went. To this day, I’m still humbled, honored and somewhat horrified that these companies put their trust in us so fully — we will forever be indebted to these entrepreneurs. We didn’t have an office yet, but once more we proved that on the Internet, nobody knows you are a dog.
Iterate: Finding what works
Using the standard accelerator model as the straw man, we iterated until we found a formula that worked for the type of accelerator we wanted to build — one that could become a fully scaled venture fund. We started out thinking we’d run a three-month program, but we now work with Mucker entrepreneurs for as long as we need to, usually around 12 months, to hit the right business milestones.
Why? Over time, we discovered that downstream investors are looking for more market validation from new ventures based in LA. Furthermore, this allowed us to work with entrepreneurs across a more diverse set of industries and stages. The average time between each round of venture financing is about 12 to 18 months, so we are essentially shepherding our portfolio companies into their next round — door to door.
Plus, we can customize our help based on the needs of the company. Every business has different product and customer development life cycles, and every entrepreneur has a different learning curve. We discourage founders from spending time fund-raising prematurely. We want our portfolio companies to focus on chasing down customers and users — they are the only people who matter at this stage.
We also used to host lots of guest speakers. But we learned that that’s great if you want to build a school, but not so great if you actually want to run a business. Our entrepreneurs prefer one-on-one access with mentors. It’s not about making introductions; it’s about digging in to figure out the optimal permutations of pricing, segmentation, product features, messaging and go-to-market strategy.
Most importantly, we figured out that to truly impact the trajectory of the businesses we invest in, we needed to get our hands really dirty. This puts the sweet spot at around 10 for the number of companies we can work with at any given time.
It turns out that the things we do are no different from what a lot of seed funds do anyway, except we do it at a deeper scale because we invest in much earlier-stage companies.
To this day, I’m still humbled, honored and somewhat horrified that these companies put their trust in us so fully — we will forever be indebted to these entrepreneurs.
Achieving product-market fit
About a year and a half ago, we went back to our original hypothesis and reviewed what we had accomplished. We have 35 total portfolio companies (plus a few still in stealth). They have been through 35 seed rounds, 20 series A (or higher) rounds, and three exits. Our accelerator companies have raised more than $200 million from venture capital firms we admire. We decided we had mitigated the risk in our hypothesis enough to actually build a real venture capital fund. In our minds, Mucker Capital was not “born” but simply “revealed.” It was time to go beg other people for money.
Now we fund-raise
No different from a startup company, raising money for a venture capital fund is a never-ending cycle. As valuations (and exits) seem to get exponentially bigger, seed funds are growing, too — partially because of the amount of capital needed to maintain pro-rata in some of these gigantic follow-on rounds. So, to continue to build this business, we needed to raise a slightly larger fund, just like any entrepreneur would have to do from seed to A to B.
With the new capital on board, we started investing in more seed rounds and in follow-on rounds of our existing investments. For the past 12 months, we have done just as many seed investments as “pre-seed” accelerator ones. Our deal flow has grown exponentially, and has grown broader and more varied. Our first classes of entrepreneurs also need us less and less as they build fundraising, business and even personal momentum.
Time to scale
Today, we are inside the tornado. The entrepreneur and venture capital market in LA has hit the hockey stick, and I no longer worry about whether we are going to be around 12 months from now. We’ve shifted our focus to scaling our business, just like a real company.
VCs (like management consultants) are notorious for being great at telling other people how to run their business, while running a very loose ship themselves. I don’t want to be that kind of VC. We have an opportunity to create an entirely new breed of fund if we approach it as a business, with all of the requisite processes, metrics, platforms enabling better outbound marketing (e.g., deal flow), customer relationships (entrepreneur outreach), human resource management (portfolio synergies), etc., on board. It’s time to scale and grow the company.
At Mucker, we are entrepreneurs first and venture capitalists second. I had never built a venture capital fund, so I built one the way I knew how: Like any new lean business venture. We got to market as fast and cheaply as we could. We wasted our own time before we wasted other people’s money. We ate our own dog food. We found product-market fit, and we are now formulating our strategy for growth.
We built Mucker exactly like the companies that we invest in and, in the end, that’s the whole point: Mucker Capital is an “entrepreneurial” venture fund in every sense of that word.
This post was originally published on Recode.
