As a Singapore based cross border VC firm, we constantly talk to our co-investors in other parts of the world, including the U.S. and Europe, to learn about whether the way they invest and operate has been affected by changes in the market environment.
In a recent conversation with a VC firm Partner who is based in Germany, I learnt that several VC firms in Europe have turned to a new model of splitting areas of investment focus among Partners of the firm. These changes only happened over the past few years, and it seems some VC firms have increasingly felt the pressure of pushing for such specialization in order to generate better returns.
With this new model, VC firms define the criterion for categorizing sectors for a new investment opportunity and let each partner be the person in charge of one or two clusters. Such categories may include healthcare, robotics & AI, enterprise SaaS or fintech. The partner who is assigned to a specific sector needs to have years of investment or operating experience in that particular sector so he or she can be the best person to evaluate the deal and contribute more to the founders and the company after the investment has been made. Whenever a partner at a particular location (e.g. London) hears about a new investment opportunity which falls into the specialization of another partner of the firm, he or she will pass this opportunity to that partner to follow up, even though that person can be based in Berlin.
This may not sound like a big deal, as in most markets, a lot of bigger VC firms have already raised different funds with different sector focuses and assigned different teams of investors to manage these funds. However, in those smaller firms where each partner primarily works as an individual contributor to manage investments, turning to such a model involves a lot of changes in the decision-making process
"Founders prefer those VC firm partners who understand the space and can open doors for them"
There are some pros and cons of following this model, but overall, I feel it is a better arrangement for those who wish to better manage the competition within the VC firm. Such competition is nothing new and may not serve the interests of LP well if not properly managed. This model allows the partner who knows the field the best to be lead to assess a new investment opportunity in that particular field. Other partners of the firm can still provide their support, but there is no competition on who shall be the lead partner for this deal as it is already set by the rule. With this model, every partner of the firm share a fraction of the carried interest of the whole fund rather than the profit from a particular portfolio company, and thus every partner has the incentive to do whatever they can to make sure each portfolio of the company does well.
In order for this model to work well, each VC Fund or VC firm needs to make sure it picks the right group of partners with the right qualification and expertise. This is less of an issue for single GP firms as the level of complexity is lowest for this end of the spectrum. We all know in the VC world, a bigger size in terms of fund size or team size doesn't necessarily translate to superior returns to LPs. Every VC firm founder needs to identify their sweet spot, reflect on which sector his or her firm can focus on and create significant value for the LPs, as well as how many deals the firm can handle and what kind of general partner can be recruited to contribute to the process.
Key drivers for such a shift in the investment process of VC firms have many folds. The first is to get access to good quality deal flow. General partners who have rich technology or operating expertise generally are the ones who already have a lot of connections in a particular industry and may know the ins and outs of the field well. They may be the ones who can smell the opportunity much earlier than pure financial investors. Good deals have no legs. Hunters who are familiar with a particular area of the mountain will be the ones who can pull the trigger and catch their prey first. The second driver is the need to win the trust and support of the founders when multiple VC firms are competing for an opportunity to lead in a deal. Founders prefer those VC firm partners who understand the space and can open doors for them. Financial investors are welcome to pay a higher price at a later stage, but founders generally don't have much expectation on them.
Which career path can make you a more successful VC investor? There can be many ways, but choosing to focus more on specialization and develop your competence around that area may be a more logical one. Those former executives with rich operating experience may stand a good chance of success, too, because the essence of early growth stage VC is a people business, a business about getting to know people, knowing how to judge people and putting people together to build a business from 0 to 1 and 1 to 10. People first, investment second.
