Lessons Learned From the Road

The Close of Scale Venture Partners IV

ScaleVP closed our latest fund, Scale Venture Partners IV, L.P., last week and not exactly in the way we had envisioned….we raised more and more quickly than any of us would have expected. While we are confident about our strategy (enough to double our GP commit in this new fund), we also assumed that it would realistically take us 6-12 months to finish. We published our PPM in early February targeting $250M, the same size as our current Fund III. We were pleased to announce that Fund IV closed last Friday, May 3rd at the hard cap of $300M.

We understand that a successful fundraise is not our primary goal but rather to generate great returns for our investors. But this milestone makes me sit back and ask, why? Isn't capital only going to firms that are now into their tenth fund or more? Having listened to our investors, I have a few observations about the venture fundraising environment that impacts us all.

Of course, the ticket to the ball is to deliver cash returns to your LPs. ScaleVP pursues investments in early-in-revenue technology companies just beginning to scale. We are pleased to see this strategy yielding consistent exits, including the recent ExactTarget IPO and the sale of Vitrue to Oracle , and we have a great crop of companies yet to go, including RingCentral, BrightRoll, Box, Docusign and Hubspot .

But while good returns are necessary, they are not sufficient…so what were the other elements at play here?

First, despite our performance and our interest in putting slightly more dollars to work per deal, we targeted the same size fund that we had before, and set a hard cap that was only 20% above that target. That size limit and consistency appealed to investors who have seen other firms increase their fund size, sometimes significantly, once they have achieved success. This brings four questions to mind for the LP:  Can the team profitably deploy a significantly larger amount of capital?  Will they need to hire a lot of people I haven't met yet? Are they doubling the size of their funds for the fees? Is there an alignment of interests? By keeping to a similar fund size, we took these questions off the table.

Second, we benefited from the interest in smaller, newer managers.  LPs know that, while they want to stay with the proven names, performance is not 100% persistent. In fact, to maintain returns, they need to selectively refresh their portfolio with a handful of next generation funds, which is why peers like First Round, Foundry, Shasta, Spark, True, and Union Square have also been successful at attracting capital.

Third, we further benefited from a broad investing trend (consistent with our own) of LPs building portfolios that are sufficiently diverse but also relatively concentrated. They expect that "buying the index" in venture by spreading small amounts of capital across many names will not get them the multiples they require out of a high risk, high return venture portfolio.  When our LPs started our early Fund IV conversations by announcing that they were pruning their portfolios and investing more per manager, we cringed, fully expecting to hear that we might be cut next. We were fortunate that instead, we had a number of investors who, having watched us through our prior funds, wanted to increase their allocation, and in a handful of cases, more than double it.

Finally, LPs want to do a lot of due diligence and want to have the time to do it. If they are going to be selective and invest in larger increments, their investing decisions get a lot of scrutiny by their investment committees, as they should. That focus on detailed due diligence included our returning investors, who started from scratch by doing on- and off-list reference calls, site visits, increased organizational & compliance due diligence in addition to a detailed review of the numbers.

Well, how did we accommodate that level of due diligence in 92 days?

The answer is advice I got when we raised for the first timenever stop communicating with investors, even if you are not fundraising. It starts by staying in regular touch with your existing investors, and not just at annual meetings or advisory board calls. See them or call them one-on-one as often as you can. Connect with them when there is good news, and more importantly, connect with them when there is bad news. We are in a long-term, high-risk business, and LPs are investing in us on a blind pool basis. The more they understand your decision-making and team dynamics, the more insight and confidence they have in your partnership. We stress the "partner" in the term "limited partner" and are incredibly grateful to have them, in turn, be so supportive of us.

Take the time to get to know prospective partners early. The best time to start that process is right after you close your last fund, when you clearly are not fundraising. With this new fund, we were able to add a handful of new investors, who had been following us for at least 5 years, and who we met with at least annually. Over that time, they not only got to know our team, they talked to our co-investors and even met some of the CEOs in our portfolio - and on an "off-list" basis, so they knew they were getting the straight scoop. Just like when we invest, they want to know a team over time to see if they do what they say they will do. For our new Fund IV LPs, the last 92 days was the end of a multi-year process, not the beginning.

The Scale Venture Partners team is fully aware that the most important focus for us is not to raise the capital for our next fund, but to deploy it profitably on behalf of the pension funds, foundations, family offices and other institutions who have entrusted us with their confidence and their capital. We will be working hard over the next 3-4 years to make sure that our LPs' decision to invest in ScaleVP was a good one. It is the heart of what we do, and our efforts are fully focused on finding the best management teams in the highest growth markets to meet that goal.

Originally published May 10, 2013.