This week, I caught up with an emerging VC fund manager who shared something interesting with me. His first two funds were small ones, so he’s been operating for several years. Now he’s preparing to raise his third fund, even though he knows the fundraising environment is rough. 

He said that raising those small funds ended up being beneficial. The management fee dollars were small, so he had a small operating budget. He was forced to be intentional about where he spent his budget and his time and to focus on the activities that mattered most and had the highest return. It’s paying off: those first two funds are performing well.

I’m a big fan of operating with constraints. Limited resources force you to focus your execution and learn from mistakes quickly, often spurring creativity. It was interesting to hear that this isn’t true just for start-up founders; it applies to fund managers too.

Louis Pasteur once said that “fortune favors the prepared mind.”

This quote is simple but powerful. The greatest outcomes are more likely to belong to those who have put in the work to prepare mentally. You can see it in founders. Those who have obsessed about a problem to the point where they understand it from all angles are more likely to create a superior solution that customers will pay for. Tons of paying customers equals a big company and accelerated value creation. You can see it in investors. Those who have gone deep into a company or sector or into developing a thesis are ready to deploy capital when the right investment opportunity presents itself. Even if it’s non-consensus and unpopular at the time. They can recognize that the opportunity is superior sooner than others and seize it before its window closes.

I’m a big fan of the prepared mind. I try to learn as much as I can about concepts, companies, and topics that interest me. This has helped me uncover unique insights and given me the conviction to do things I otherwise wouldn’t have done. I’ve made it a priority to make time regularly to do this. 

A prepared mind is something everyone can have—but few do. Most don’t make the effort. It’s a great life hack—a way to separate yourself from everyone else.

I had a conversation this past week with another investor, someone who invests broadly in various asset classes. He shared that when he’s considering an investment, liquidity is a priority. I think of liquidity as the ability to turn an asset into cash easily by selling it within a reasonable amount of time without having to discount it significantly. Liquidity usually means there’s a healthy market of buyers and sellers of an asset. Many investors consider public equities a liquid asset class because stock markets (e.g., NASDAQ and NYSE) bring buyers and sellers together regularly, so shares in public companies can easily be converted to cash.

I’ve been thinking about liquidity more since my conversation this week and wanted to get some different perspectives on the topic from seasoned investors who’ve had outsize success. I came across an interview of Seth Klarman, a billionaire investor, CEO of Baupost Group, and author of the hard-to-find investing classic Margin of Safety.

Klarman shares his views on liquidity after decades of investing. Two things jumped out to me. First, illiquidity comes with a cost, and investors need to be paid for giving up the right to change their mind. In other words, if you buy something that can’t be easily sold, you need to be compensated for being unable to change your mind and easily sell the asset. Second, assets in a seemingly illiquid form aren’t necessarily illiquid. For example, a stake in a building is thought of as an illiquid asset. However, if you own 100% of the building, you can decide when to sell it. Buildings get sold all the time, Klarman said, so this asset is in an illiquid form but is actually liquid.

Klarman made some good points about liquidity in this interview. If you want to hear the rest of his views on liquidity, check out that section of the interview here. 

I read an article this week about Airbnb. My experience with marketplaces makes them an area of interest for me. I enjoy reading how publicly traded marketplace companies navigate the complexities of the business model at massive scale. In the article, Brian Chesky, CEO and cofounder of Airbnb, was very candid about his company. 

Chesky said the company isn’t on a solid foundation. In fact, he claims the company never built a solid foundation. The Airbnb system was intended to serve a much smaller company, but Airbnb ended up growing “like crazy.”

Chesky outlined a few things they need to do to get their house in order. The one that really caught my attention was a focus on reducing prices. Chesky said attractive pricing was what drew people to the service. It sounds like he wants to return the company to being known for affordability.

That makes sense, in a way. Lower price points usually lead to an increase in demand. On the other hand, there could be a limit to how low some hosts can go. Especially when you consider that some of them have leverage (i.e., debt) on their properties.

Those are just two of the many things I thought about after reading this article.

Marketplaces are hard. Keeping the customers (the demand side) and the merchants (the supply side) happy is no easy task. In my experience, when changes are made that materially affect how much revenue the supply side receives, a period of uneasiness and “adjustment” usually occurs.

Airbnb is massive, so I’m curious to see how this all unfolds and what the impact will be on Airbnb’s financials and on the entrepreneurs who make a living as hosts on the platform.

I recently had the chance to have a long meeting with an emerging venture capital fund manager. He launched his fund less than two years ago. He’s been able to secure early investment from a few limited partners (LPs). Enough to assemble a team and begin investing—but nowhere near his target amount. The fundraising environment for emerging venture fund managers has been tough in 2022 and 2023. I was curious how things were going for this manager.

He shared that his journey has been full of highs and lows. Fundraising has been extremely hard. The interest-rate environment has soured many potential LPs on venture capital as an asset class, especially for new fund managers. Some potential LPs who like his thesis have shown interest, but their internal rules won’t allow them to invest because this is his firm’s first fund. (Some LPs consider investing only if it’s the second fund or later.)

The fundraise is behind target, which has created a cash flow issue. He took a pay cut to less than what recent college graduates make, which has made things less than ideal at home. And he’s made other adjustments in the firm to conserve cash.

He doesn’t think he’ll raise the amount he targeted when he launched the fund. It will likely be materially less. He’s traveling every week for the next few months to meet with LPs across the country. His focus now is to get enough capital commitments from LPs to safely execute his strategy with his current team before he legally must end his fundraising process. If he can raise the minimum needed for the fund to remain viable, he’ll have enough runway to build a track record that he hopes will help when he raises for a second fund.

On the positive side, the team he assembled is extremely talented. They’ve refined their approach and have a solid process to discover, evaluate, and win investments into promising start-ups that fit their thesis. They’ve completed investments in several companies, all of which are doing well and have ample cash. One early investment is doing exceedingly well and has raised again from a well-known VC firm. That investment is his firm’s first markup in its portfolio and validation from a later-stage investor.

This fund manager is smart and determined. I have no doubt he’ll ultimately achieve success. It may look different and happen slower than he originally envisioned. But I believe it will happen for him. 

His story is a reminder that the journey of an emerging fund manager can be the same as that of a start-up founder: one of sacrifice and extreme peaks and valleys. Market conditions are making the journey particularly tough. If current conditions persist, they could lead to fewer people launching new venture funds.

A few days ago, I shared an interview of First Round Capital Board Partner Chris Fralic regarding the firm’s thinking when it made an early-stage investment in Roblox, an online gaming and game-creation platform. Fralic mentioned that Roblox was one of the firm’s best investments ever. That caught my attention and made me wonder just how good of an investment it was. So, I did a little digging.

Roblox went public via direct listing in March 2021. Its market capitalization (i.e., valuation) was ~$35.5 billion when it began trading on the first day and ~$38 billion when trading closed for the day. According to Roblox’s S-1 filing (page 172), First Round owned 6.8% of Roblox when the company filed to go public. The S-1 filing also shows that First Round registered zero Class A common shares in the direct listing (page 172), which I assume means that it planned to sell its entire position. Assuming that First Round sold at or around the $35.5 billion market cap at which shares began trading on the first day, its position was worth approximately $2.41 billion.

The S-1 filing also shows that First Round made the Roblox investment via a single entity, “First Round Capital II, L.P.” (page 172), which likely means the firm invested into Roblox out of its Fund II. Note: When companies go public, you often see venture capital firms have spread investments across several entities, which makes it harder, if not impossible, to calculate the firm’s return. For example, the S-1 lists Altos Ventures as an investor owning 23.6%, but according to a footnote, its ownership is spread across numerous entities (page 172).

I did some digging on First Round’s Fund II. It was reportedly of 2008 vintage (i.e., that was the year it was raised) and totaled $125 million raised from limited partners (LPs).

When VC firms pitch LPs to invest in a fund, they usually communicate a 10-year life cycle to the LPs. This means that VC firm general partners plan to deploy the capital raised from LPs into start-ups, exit those investments, and return proceeds to LPs all within a 10-year period. That’s the plan, but things don’t always go as planned.

At the time of Roblox’s direct listing in March 2021, First Round’s Fund II may have been three or so years past the 10-year fund life cycle. It makes sense that the firm would liquidate the entire position when Roblox went public so it could realize and distribute the gains from the Roblox investment to LPs and start winding down the Fund II entity (assuming that no other active investments remained).

It’s hard to know the exact return on this investment, but I made some guesses at the fund level. If this direct listing resulted in about $2.41 billion being returned to the fund, that means the direct listing alone returned about 19.2x the entire $125 million fund. That’s astonishing when you consider that a stellar return for a seed fund is in the 3x–5x range. It’s even more astonishing when you consider that this estimated 19.2x return doesn’t include cash received from selling Roblox shares in the years leading up to the direct listing (which Fralic confirmed the firm also did) or returns from other companies that Fund II invested in (Uber appears to also have been a Fund II investment (page 266)).

It’s easy to see why Fralic says Roblox was one of First Round’s best investments.

A few days ago, I shared that Bessemer Venture Partners posts the deal memos of some of their most successful investments online. Along the same lines, I recently found an interview in which First Round Capital Board Partner Chris Fralic talked about the firm's thinking when it invested in Roblox. First Round Capital is a seed-stage venture capital firm and often writes the first institutional check into a company. Roblox is an online gaming and game-creation platform. Per Fralic, Roblox was one of the firm’s best-performing investments. 

A few interesting takeaways from the interview:

• In early 2009, First Round passed because the $10 million valuation was too high
• Chris watched his son and his son’s friends spend increasingly more time on Roblox throughout 2009
• Chris maintained a relationship with Roblox even though his firm had declined to invest
• Six months after declining to invest, the firm wrote a $500k check at a $14 million valuation
• In May 2011, the firm wrote a $3 million investment at a $40 million valuation
• Roblox was a company that was mostly substance, not hype, so it flew under the radar of many venture capital investors for many years
• First Round sold some of its shares along the way before Roblox went public
• First Round owned more than 5% when the company went public via direct listing in 2021

Roblox went public via direct listing in March 2021. Its market capitalization (i.e., valuation) was ~$35.5 billion when it began trading on the first day. According to Roblox’s S-1 filing (page 172), First Round owned 6.8% of Roblox when the company went public. Its position was worth ~$2.41 billion when shares began trading.

It was interesting to hear a VC firm partner recap how he decided to invest at the seed stage of what ended up becoming a very large company.

For those interested in learning more, Chris did a great job of detailing his reflections, lessons learned, and more about First Round’s partnership with Roblox in this blog post too.

Update: Chris' original blog post was taken down from Medium. You can now find the blog post on First Round's website here. You can also view this thread from Chris on X (formerly Twitter).

A few months back, I shared that 2021 was a gargantuan year for IPOs, with 1,035 of them—the highest number I could find in the last quarter century. 

In 2022, we saw just a fraction of that number of IPOs, 181 to be exact. As of the writing of this post, we’ve had 114 IPOs in 2023, which means we’re tracking for fewer than in 2022.

A few weeks ago, I shared my thoughts on the draft S-1 filings by Instacart and Klaviyo in anticipation of going public (see here and here). This week, both companies held their IPOs (NASDAQ: CART and NYSE: KNYO). Both offerings are complete, and the companies are now trading on public stock exchanges.

I suspect that venture capital investors and founders of late-stage tech companies will closely watch how both companies perform in the public markets over the next few weeks. If their stock prices are flat to up, we could see an increase in the number of technology companies filing to go public and maybe even see more IPOs in 2023 than in 2022. If their stock prices fall materially, I wouldn’t be surprised if 2023 is another year of declining IPO activity as companies elect to wait for better conditions in early 2024.

For better or worse, these companies will likely have a material impact on upcoming IPO activity and technology investor sentiment.

One thing I’ve noticed is lots of media reports about IPOs being priced at valuations below their most recent private fundraising round. Instacart is an example. A few founders and friends trying to make sense of this asked me about it. Why would you take a company public at a valuation materially below its valuation in your last VC fundraising round?

The answer can sometimes be related to needing to raise more capital but being unable to do so privately because of cap table complexity. I recently listened to Bill Gurley, a famous VC investor, articulate why IPOs can be the easiest way to raise capital when a company has a complex capitalization table.  

For anyone interested in understanding this topic better, Bill shares his thoughts in this clip and this one.

I received an email about a small SaaS business that’s for sale. It has a few hundred thousand dollars in revenue and is profitable. I was curious how the market is valuing small companies like this, so I read through the email. Here’s what I found:

• $594k revenue (I assume trailing twelve months)
• $39k monthly recurring revenue
• Revenue has declined since purchase by new owners in 2020
• 1500+ customers
• ~$600 customer lifetime value
• 4.8% revenue churn (I’m assuming annual)
• $240k seller’s discretionary earnings (SDE)
• $750k asking price (i.e., 3.1x multiple on SDE)

If I were in the market for something like this, I’d have lots of questions for the seller, especially about the quality of the revenue and profits.

One thing that got me thinking was that this business was purchased in the last three years or so and has seen the revenue decline. I wonder about the cause—is this a case of customers seeing less value in its solution, or is it less-than-stellar management by the current owners? Not an easy question to answer until you dig into the business, but depending on the answer, the business could be a great investment opportunity or a less than ideal one.

I wonder how many small businesses have been purchased in the last three years and have been declining since then? How many have turnaround potential and will be put up for sale in the short or medium term?