We are entrepreneurs too. We feel your pain.

We are entrepreneurs too – we feel your pain!

I occasionally half joke with entrepreneurs that we are entrepreneurs too who are building a startup venture capital business and we have particularly felt their pain whilst we did our own fund-raising last year.

Entrepreneurs come to us looking for money to prove their product-market fit and sales model, to hire more people to develop and to succeed in a crowded and competitive market place.   When they raise a successful seed round from us they work their butts off to get a great Series A investor to invest in them at the next round, usually about 2 years later.  They might move from a cheap shared office to a proper office to house a growing team at that point.  And the journey continues – team growth, sales growth, challenges with growth, more fund-raising and eventually an exit.  We hope!

We had the same journey with Episode 1.  And here’s what we learnt. Love your existing investors, do what you say you’re going to do and communicate strategic changes openly, focus on your product/market fit (our entrepreneur-centricity which we developed), refine your Go To Market strategy & positioning (for us – early in, high-support, conviction investing), and then be sure to cater to the care-about’s of the next stage of investors (for us – large institutional investors).  And prepare for your next fund-raising in very good time – we didn’t realise that final point until we started raising Fund 2 which turned out to be a bit late for most large institutional investors… But we ended up in a great place, over-subscribed and supported by a superb list of Limited Partners.

Here’s the story in a bit more detail, and if the entrepreneurs reading this put themselves in our shoes I think you’ll find our journey surprisingly similar to yours.

Simon, Damien, Paul and I started Episode 1 Ventures as our startup in mid 2012.  We used our own sweat equity to build our proposition as a hands-on, operationally very experienced, straight-talking Seed stage specialist.  There was less competition back then – to the extent that the British Business Bank (BBB) funded us to the tune of £25m to fill this equity gap.

It took us a year of fund-raising efforts to raise the balance of our fund from private investors, who were incentivised by the attractive terms of the government money from the BBB  – sound familiar?  Fund-raising for startups at the same stage in their journey often take up to a year to fill their pre-Seed round, usually in 2 rounds, one SEIS and one EIS, and they approach very similar people – Angels, incentivised by tax breaks through EIS and SEIS.

We ran our first fund for 2.5 years before starting out on our “Series A” fund-raising journey – our 2nd fund.  At this point we knew what we were doing as a business – we had hit product/market fit. We had a clear proposition in the market, some “sales” (a portfolio of 20 companies), some awesome employees, and evidence of growth (in the portfolio companies – particularly CarWow, TripTease, AimBrain and TouchSurgery).

Like startups which are looking for a brand name investor at Series A, we wanted to get some non-governmental institutional investors into Fund 2 as we expect that the BBB would be looking to reduce their exposure into our next Fund (3) and wanted to start relationships with those larger institutions (Fund of Funds or Pension Funds or the larger Family Offices) immediately.

We were luckier than most startups at this point – our lead/anchor investor was happy to lead in Fund 2.  The BBB put £36m into Fund 2 meaning we had to raise £24m to hit our £60m target.  Most startups will not be in that position – the market practice is for the original Seed lead investor (like Episode 1) to insist that a new investor leads and thus prices the Series A.   Why?  Because we, as investors, tend to fall in love with our portfolio companies and will not necessarily price subsequent rounds entirely rationally.  Also, our pockets are deep, but not as deep as the larger later-stage investors who can financially support the companies for longer than we can.

£24m is a lot of money.  Not to behemoths like Index and Accel who often get more than that amount from a single cheque, but to a Seed fund with 1 fund and no exits like ours, it’s a lot!  Hence the desire to get larger institutions to invest – when 1 meeting can yield millions of pounds, that is time efficiently spent.  Unfortunately, without an extensive track record of at minimum 2 funds, most institutions will choose to wait and watch until Fund 3 or 4 is being raised.  So we had to meet a lot of high net worth individual and smaller family offices….which was great fun for me, by the way, but it took plenty of time.

What is also similar to startup fund-raising for us is that once there is the perception that the opportunity to invest is becoming scarce, suddenly investors start to say yes a lot quicker!  It’s harder to find those investors who have the conviction to take the first leap.

We were/are very fortunate to have a supportive investor base from our 1st fund.  65% of our original investors re-upped into Fund 2 despite our having returned no money to them at that point (we are very early stage investors so exits take time).  This certainly helped bring in our new LPs alongside the fact that we as GPs were committing 17% of the private money or 7% of the overall £60m fund – the market standard is <5%.

Over the course of 2017 we contacted just over 200 investors, including the 42 in Fund 1, so that’s about 160 new potential LPs.  We ended up with 87 investors in Fund 2, though the real number is around 65 as quite a few of our LPs shared investment with their spouses and / or kids as separate names on our LP list.  27 of our Fund 1 investors joined us in Fund 2 so that means 38 brand new investors.  Each investor we contacted required at least an hour’s meeting, usually from 2 of the GPs and those that we converted probably reach required about 3 hours from 3 GPs.

If you do the maths that amounts to around 800 man hours of meetings.  Add on top of that all the preparation and legals and it would easily be double that.   That’s about 180 working days of work to raise our Fund.   All whilst managing a portfolio of 20 companies.  I’m not asking for sympathy, but, damn it was hard work…..!  Hence the “feel your pain” point.

According to Prequin, a data provider to the PE industry, there were 590 first-time or spin-off VC managers active in 2017.  In addition, half of all VC investors on their database have committed or are committing to first time or spin-off managers.  What does that all mean?  Well, there is clearly demand for first time or spin-off funds (probably because first-time funds often outperform later funds – median net IRR of a first time fund is 13% vs 9% for non first-time funds, albeit with a higher standard deviation of returns), but what about raising a 2nd or 3rd fund?

According to Pitchbook, of the 117 VC firms launching their first funds between 1998 and 2015, 58 were able to raise a 2nd fund – ie 50% of first time GPs managed to raise a subsequent fund.    That is a lot better than the 20% of Seed funded companies getting a Series A*, but still a sobering thought.   As for getting from Fund 2 to Fund 3, for the same date range the 78 GPs running their 2nd funds, 31 or 40% managed to raise a 3rd fund.  This is in fact exactly the same % as the “graduation rate” of tech startups in Europe that have raised Series A getting their series B.

We have achieved our “Series A”, our Fund 2.  We are moving into some lovely new offices of our own after 4 happy years in a shared office.  We have hired 3 new awesome team members, Carina, Siobhan and Anouk.  Otherwise, it’s heads down.  We are working towards our “Series B” – our Fund 3!  And of course, looking for the very best software driven startups in the UK looking for their first institutional round of financing.

*Atomico report on the State of European Tech 2017

Adrian Lloyd
Half Swiss. China obsession at Oxford. Tech obsession at Stanford GSB. Strategy consulting to Venture Capital. Tennis, skiing, Cresta riding. 4 young children, a boxer. Fabulous artist wife, Print-maker.



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