Free Business Plan: How to start a venture capital fund in New York City

I’ve spoken on many occasions about now New York City doesn’t necessarily need more money for early stage startups, but it definitely needs more dedicated early stage money.  There’s a big difference between a random pool of stimulus money that may or may not be around next year versus an actual early stage venture capital fund that raises commitments to put early stage money to work over the next four years.  In reality, VC funds are usually given the benefit of two funds.  When capital is raised for a second fund, the first fund is usually mostly unrealized and “too early to tell”.  That means that for each new VC fund manager, you’re almost guaranteed to get about a decade of new investments. 

When you have that kind of commitment to a space, your presence will not only attract more entrepreneurs, but you’ll be highly incentivized to do the work to make the long term social capital and community infrastructure investments to ensure a vibrant innovation ecosystem.  You’ll build relationships with universities, incubators, community groups and even big corporations—relationships that may not have an immediate payoff, but are likely to come in handy if you’re going to be here a while sourcing, investing in, and supporting startups. 

For whatever reason, as I’ve said before, there aren’t very many funds in NYC doing early stage investments.  Lots of people have asked me about what I’ll do after Path 101, and I think it's probably likely I'll return to my investment roots.  When the conversation turns to bringing my network and experience to a VC firm, the resulting conclusion is that I’d probably need to be the NYC guy for an out of town firm.  After crossing Union Square Ventures off the list, since I already worked there, the number of NYC funds who will regularly do pre-revenue deals is pretty small. 

However, given the number of really interesting things going on in NYC, many of which are getting funded by out of town firms, you have to imagine there’s an opportunity in the market to build another early stage VC fund here.  The interesting question, one that I explored with a couple of people over the last week, is how you would go about setting up a new VC fund. 

It's an interesting exercise.  Here are, in my mind, some of the key questions and issues that you’d have to address in setting up a VC fund in NYC, and how I think someone should go about addressing them:

The Shadow of Union Square Ventures

No matter what you think of their portfolio or style, I think you have to concede that Union Square Ventures, in its relatively short existence compared to other firms, has grabbed the venture capital spotlight in NYC.  Not only is it an early investor in highly sought after deals like Twitter and Foursquare, but the mindshare they have captured, largely through Fred's blog, is a very valuable asset and a competitive edge.  Does that mean that a new firm would have a hard time not being seen as second fiddle at best?  Would there only be scraps left at the table?

The answer is no--not even close.  If anything, Union Square Ventures, and the other local firms like RRE and Firstmark are actually looking for more local partners.  Many of their deals have been done with other VCs, so a firm with close ties to USV would seemingly have a good opportunity to see their dealflow.  That being said, there are many more deals to go around than just what USV is seeing and doing, and they certainly don't see everything.  There are lots of great deals being done by non-USV firms--some that turn out to be extremely successful like Right Media, Conductor, Pontiflex, bit.ly and Gilt Groupe.  I actually know of a couple of deals where other local firms were looking for a partner in town and couldn't find one. 

Even so, if you're worried about the specter of USV, it seems to me that there's plenty of opportunity for a NYC firm to grab additional mindshare from local entrepreneurs.  The entrepreneur appetite for intelligent public discourse coming from a NYC firm is enormous and, if anything, there's a bit of a shortage.  Most of the active NYC investors, especially if you count angels, don't necessarily blog and even some of those that do don't really count on it as a pillar of their brand the way USV does.  A new VC firm would have lots of opportunity to build brand equity in NYC by engaging in public discourse.

Branding

The public perception of much of the NYC startup investor crowd, including the angel scene, is that it's a bunch of former bankers and others that are unwilling to make the kind of bets long on vision that are made each day in the Valley.  NYC is known to be friendlier to sales execution plays versus technology innovation.  A new NYC VC firm would have to send a strong signal to the market that it isn't a bunch of bankers just looking at spreadsheets for direction on how to change the world.  It could make a lot of headway by focusing on technology and product focused innovators and participating in both online and offline conversations.

By fostering and participating in these discussions, like USV does with their Sessions talks, a new firm would attract smart technologists and innovators into their social circle.  There's still only one venture capital firm whose corporate site is a blog--so there seems to be plenty of opportunity to market an entrepreneur focused fund in NYC.  You could also take a page from the First Round playbook and do open office hours--giving any entrepreneur the opportunity to come in and pitch their business or get feedback. 

There's also something to be said for having a more national presence in your branding and not just being seen as a local player--both among the entrepreneur community and among other VCs.  Venture firms often see deals through relationships--ones that span geographic boundaries.  That's how Redpoint found Right Media even though it wasn't necessarily looking at NYC for deals--they got introduced to it through another company (I think a portfolio company).  You also want to be seen as a smart partner for an out of town firm who finds a good company in NYC. 

Entrepreneurs, too, are connected across geographic boundaries to other entrepreneurs.  I can't tell you how many times I meet other NYers at out of town events.  Often times, when people are in their home city, they're too busy with their heads down doing work and so your best times to meet them are during conferences and meetups in other cities.   

Leveraging the infrastructure

One thing that I haven't seen NYC firms do that well is leveraging the existing innovation infrastructure in NYC--or, more accurately, turning it on.  Local NYC educational institutions have very few connections to the investor and startup community compared to the West Coast and places like Stanford.  A VC firm will sponsor the occasional business plan competition here, but we're not generating the same kind of awareness among the best and brightest from local schools that entrepreneurship and technical innovation can be a career.  We need to start pulling more students into our innovation community in a systematic way, and sending back more professionals, both technical and on the business side, into the classrooms. 

Big corporations could stand to be a bigger part of the local startup community, and a new venture firm would do well for itself to try and find better ways to tap into the huge businesses that thrive in the Big Apple.  By being a conduit for trends and technologies, not only could a new local VC firm create a powerful network that could result in lots of business development opportunities for its companies, but it would also sow the seeds of entrepreneurship into the existing corporate infrastructure.  There are still lots of well trained technologies inside big companies--ones that are building world class applications that scale.  They need to see more supporters of the startup community in order for the cloud of risk aversion to completely go away in this city. 

A new venture capital fund would not only have to be a friend to and active participant in the local community groups, like nextNY, NY Tech Meetup, Digital Dumbo, NYC Resistor, Future Y+30 Meetup, etc., but also be a catalyst for top tier efforts to setup shop here in the city.  There absolutely needs to be a TechStars NYC and an FooCamp NYC.  That would tie a new VC fund in with a great innovation network and help give NYC a bigger pin on the map--which is good for all local investors, but especially for the one that makes it happen. 

Staffing

After evaluating top tier venture capital firms at the GM pension fund for four years and being a part of one at Union Square Ventures for almost two, and then pitching them as an entrepreneur--I've got a couple of opinions about the optimal human capital deployment at a VC firm.  For one, early stage investing absolutely needs to be driven by the decision makers.  Two analysts will not source twice as many early stage deals as a single principal or partner--someone who can lead a deal.  Sourcing basically means being able to add a deal to your deal log or setup a meeting, which isn't a function of actually doing deals.  Decision makers are always the throughput bottleneck.  If you can't get a company in to see a partner or principal, and get them to spend time on it, that deal isn't going anywhere. 

It's fine to have your analysts vet the dealflow from businessplans@venturefund.com, but anything viable really needs to be touched in some way by a more senior person, otherwise you're outsourcing your screening process to the people with the least experience.  Not only that, getting your decision makers out there in front of as many deals as possible in a space helps their education on the opportunity set, because markets are constantly evolving.

Hiring more analysts than senior people seems upside down to me.  If you look at most venture capital firms, they tend to have more partners than analysts.  The exceptions are growth venture firms like Insite, TA, and Summit, where you have teams of analysts and associates "dialing for dollars" looking under every last rock for growing companies they can put equity into--finding random POS software companies grown out of family businesses in the back woods of PA somewhere.  The types of
deals that an early stage fund would be doing comes from a much narrower universe of innovators--one that is mined best by early engagement by decision makers, not analysts.  When a top entrepreneur gets a phonecall after an angel funding, they'd much rather hear from a partner who finds their company interesting because they have experience in that space and a thesis, not an analyst running through the "How do you make money?" question playbook.

Prominent senior people are driving just as many deals as a "funnel" that would otherwise start with a bunch of analysts turning over every rock.  They build reputations for being knowledgeable in a space, good board members, etc. and the best entrepreneurs seek them out--as do other venture firms.  They don't seek out analysts.  In an era of VC transparency, when entrepreneurs know exactly who the partners and principals are and they're more reachable than ever, analysts are often seen as unnecessary friction--no offense, but I was in your shoes, too.  Three more of me at USV would not have tripled our deal pace. 

Analysts make sure the ball isn't dropped on process, that all the blind spots are covered, help shepherd closings through and are good for keeping a finger on the pulse of the young innovators. 

The bigger question, besides seniority, is *who* exactly in NYC would you start a new VC firm with.  Would you try and peel off a principal at another fund who has lots of deal experience?  A serial entrepreneur looking to switch gears?  I'll leave this question somewhat open and I'd be interested in who your "dream team" for a new VC fund would be if you could choose from among folks you could legitimately get.  Whoever it is, I think it would have to be someone who conveys authenticity and has enough credibility within the existing community that they're not seen as an outsider--someone who just wants to stuff cash in their company and replace them as CEO like some evil VC with a handlebar mustache. 

Stage

The NYC scene is wide open to be mined by a new VC doing pre-revenue deals.  A few top firms, given the stage of their own fundraising, are now leaning towards doing revenue deals that might have an exit closer on the horizon than a totally new company.  Many of the folks lining up to do Foursquare, for example, were not NYC-based.  Any NYC based investor who got to know Dennis as early as Bryce from OATV did would have had a shot at that deal.  That's why, if I were setting up a NYC fund, I not only would be focused on pre-revenue deals, but I might even carve out some capital for a pool of early, somehwhat passive angel type investments--maybe in conjuction with a TechStars type program or like Start@Spark

I don't necessarily think someone will come along and start a VC firm because of this post, but I think it's worth talking about the model of relating to entrepreneurs and supporting innovation in the community so I'll end it there and let said community finish the rest of this post in the comments...