PS#018: Big firm or small firm? (Part 2)

OK, today, we’re going to discuss small, new firms.

Before we dive in, let’s recap…

Remember – it’s all about what you can learn.

This is a long-term game, so we want to position ourselves to learn as much as possible early in our careers. This will pay dividends later in our career.

We’re trying to learn the skill set of a full stack venture investor, including…

• Sourcing and networking

• Evaluation and due diligence

• Negotiating, structuring, and closing

• Portfolio construction, management, and support

• Firm management, fundraising, and LP management

And, we’ve got a framework for making this decision.

Framework below:

• Deal flow

• Exposure

• Advancement

• Compensation

• Responsibilities

More details on these in my Part 1 of this series.

OK, let’s jump into the pros and cons of a small, new firm.

Small firm – pros and cons.

Deal flow

Deal flow refers to the volume, types, and quality of opportunities that a firm can generate.

Small, new firms are just that – they are new to the scene. They are still building their brand and reputation in the market. Sometimes, the general partners for these firms will already have a well-established brand that allows them to generate high quality deal flow. In other situations, they are new to venture capital and are starting more from scratch. In either case, the fight for quality deal flow is harder than if you were at a big, established firm.

As a new investor, this is a double-edged sword. You will have a lot of autonomy to help generate deal flow, but less of the awareness in the market that a big, established firm can provide. You will be forced to build your own brand that can attract deals in the market. While difficult, this is a key part of being successful as an investor. The earlier you can build this, the more you can separate yourself from the pack later in your career.

Pro: The autonomy to build your own brand and create your own sourcing engine, independent of the firm’s brand and reputation. If done well, this is the ultimate super power in venture.

Con: The battle for high quality deal flow will be more difficult, requiring more time dedicated to building inbound and outbound sourcing channels, relationships in the ecosystem, and your own point of differentiation as an investor.

Exposure

Think about exposure on two fronts: (1) venture capital skills, and (2) business building skills.

While big firms allow you to see venture at scale, small firms can show you the journey from 0 to 1. Due to the small size of the fund and lower management fees, individuals at the firm are forced to wear many hats. Where big firms have specialized teams, at a small firm, investors have to work across the different components of the business, including the investment process, legal review, portfolio management and support, internal operations, fundraising cycle, etc.

Pros: As an early investor, you will be able to have your hand in everything, the full stack. Even better, you won’t just get exposure, but will be actively involved in driving these activities forward. Your day-to-day will have a lot more volatility and may include any or all of the items I listed above.

Cons: The value of this exposure will be impacted by the success of this new, small firm. If the firm struggles to raise funds, you won’t be able to do any deals. If the firm struggles to find quality deal flow, you won’t be able to make good investments. If the firm is not making good investments, you won’t have as much exposure to supporting companies as they scale. And so on, and so forth.

Advancement

Do you have room to grow as an investor?

While this very much depends on the situation, you will have a higher likelihood of being able to advance at a small, new firm. Similar to startups, if you’re helping a firm go from 0 to 1, you’re creating some irreplaceable value. This can be turned into a path to being general partner or at least some quicker progression on the “title” you hold at the firm. As I mentioned in the previous issue, the jump to general partner is a big one. However, at a small, new firm, the current general partners will have a very clear view on whether or not they see you as a part of their partnership in the future.

Pros: If you perform, you will have a higher likelihood of being able to join the partnership as a general partner in the future. This is often something that you can discuss with the firm upfront, with the assumption that you still need to prove it.

Cons: While I say higher likelihood, it is still a big jump to general partner and not many investors make that leap. Sometimes, these smaller firms have no intention of expanding their partnership, meaning there is no long-term opportunity for you. Figure this out sooner rather than later.

Compensation

How much can the firm afford to compensate you?

Small, new firms are often constrained by their management fees. If you aren’t quite sure what this means, take a look at my guide on VC compensation. Due to these constraints, these firms aren’t able to pay market rates and are often well below bigger, established firms. In most cases, the lack of cash compensation can be balanced by an increased access to carry.

Pros: While your cash compensation is low, you can often balance this with more carry.

Cons: The cash compensation can be shockingly low at times. Many of my former students (who are now in venture) were surprised at how low it was, even for more senior roles.

Responsibilities

What will you be responsible for at the firm?

Again, this is a big question. I believe that what you do every day has a big impact on your learning and overall growth (probably a bit obvious). With a small, new firm, you can be responsible for a lot, everything from the investment process to internal operations. This means that you could learn a ton about the inner workings of a venture firm, but it also means that you may have to do a lot of logistical work outside of just pure investing. It’s a double-edged sword.

Pros: You will have opportunities to dive into anything if you prove that you can handle the responsibility (i.e., diligence, structuring, portfolio support, etc.). In a lot of cases, you’ll have to because there isn’t anyone else!

Cons: You may be forced to take on a lot of administrative duties that don’t tie to venture. When you’re small, people need to wear many hats. Venture firms are still businesses and they require more than just investors investing to keep them running.

As with everything, it depends.

We’ve now looked at the two opposite ends of the spectrum – big, established firms and small, new firms. Both of them pose plenty of pros and cons. And truthfully, each situation is unique and brings its own characteristics to the table.

My advice is to evaluate each situation with the framework I’ve outlined above and make the best decision for YOU.

It’s not easy. You may not get it right on the first try.

But, remember, this is all about getting a seat at the table so that you can learn as much as possible as quickly as possible.