Let’s go back in time to 1999. A lot of Internet companies were overvalued and the market was about to crash. But a very, very young Google was raising money and Ron Conway was investing at an earlier level than almost anyone.
Even if you knew then what you know now about the runaway success Google would become, that doesn’t mean you could get into Google.
But there’s another way you could get Google stock at that price. You could have been a limited partner in Conway’s fund. Steve Bennet was lucky enough to be in that position— and it was really only “lucky” because of Google. So many of those Internet companies in that fund flamed out, as he remembered.
“My first LP investment was in Angel Investors, back in 1998,” he remembers. “It was an index fund of basically Internet startups and it would’ve performed horribly except for the fact that one of the companies they invested in was Google. So I’m still holding Alphabet stock at a 20 cent basis and it’s at $250-something now.”
That’s the power law for you. It’s an immutable rule of startup investing no matter how good you are. Cycle after cycle 5% of the deals are going to make 95% of the returns. Unless you are able to write a lot of angel checks and have the world’s best deal flow, it often makes sense to put a $20,000, $100,000, or even $500,000 check as an individual into a fund instead of a single angel deal.
That was a big take away from our LP Roundtable on September 16, featuring two top LPs, entrepreneurs and investors, Bulent Celebi and Steve Bennet.
And now that emerging funds are getting even smaller, you can often become an LP for the same price as an angel.
Is it time for you to graduate up the ecosystem? It comes down to access, due diligence, luck and the power law.
How much access do you have?
How much due diligence do you want to do?
How lucky are you?
And well…are you making enough bets that the power law will eventually break in your favor?
If not, you might consider jumping the food chain from angel to LP. From the people who invest the smallest checks the earliest and usually hold the least sway on the cap table to the people the VCs work for.
“It’s not only the emerging managers but the team they are building around themselves who are doing a lot of the heavy lifting,” Celebi says. “They are the ones actually going and getting this deal closed, analyzing these companies, and they are going to do a far better job than I am given the amount of time I have to spend on it. I really don’t want to spend my time doing legal due diligence on a company. With a relatively small check you can get into these emerging managers and VC Lab is a great funnel for them.”
Celebi focuses on funding emerging managers with very deep domain expertise and connections. He wants to find people so well regarded in a field that founders will want them on their cap table, even if a round is oversubscribed. In over-heated markets like AI, that’s the only way to get a small check into these massive oversubscribed rounds.
“The emerging managers I’ve invested in are so good in their specific topic, even though there are other big name investors in a round, they are still able to get an allocation because the founder wants them on the cap table,” he says. “That’s who I’m looking to invest in.”
That’s a much easier way to invest in a hot new sector than trying to build that expertise and network from scratch yourself.
Bennet pointed out that in addition to giving you better odds at an upside it limits your downside.
“You hear a lot more about the people who have had huge successes angel investing than those that have lost all their money but there are a lot more of the ones who have lost all their money,” Bennet says. “A fund may return or not return; you may only get 50% back or 75% back, but you’re probably not gonna lose your entire investment.”
But Bennet also pointed to other reasons he started investing in funds, even while also investing as an angel.
Investing in a specialist emerging manager helps him learn about a new area he’s curious about, it surfaces hot deals he might want to co-invest in as an angel, and he gets to know up and coming VCs who may want to co-invest in deals he’s an angel in.
“It’s a way to get smart about the market and see what’s going on,” he says. “You get a ton of information, you get quarterly reports on every portfolio company. I mean, you look at PItchBook and you see how wrong most of it is because it’s a bunch of 22-year-olds cold calling people trying to get information. I’ve spent my whole career in this venture ecosystem and everything is symbiotic here.”
Anything that gives you an edge over the power law.