Thread by @robgo

I’ve noticed an interesting trend among early stage VC funds: A heightened focus on fast markups and early fund performance metrics. It got me thinking – is this a good or bad thing? 🧵

First, definitions📔 A fund marks-up an investment when another firm invests in one of their portfolio companies at a higher price. This increases the holding value of this investment, and improves the IRR and TVPI of the fund.

/1

When I started in VC, markups were useful validation that a new fund knew what it was doing. But there was relatively less fixation on performance numbers early in a fund's life. This seems to have changed. Why?

/2

10+ years ago, VC wasn’t doing great as an asset class. Overall performance was *meh*. But this meant that LP’s were used to funds having more of a slow start, and so there was less focus on short term marks.

Long term value creation was what mattered 🌱

/3

This makes sense. The point of an early-stage fund is to find monster outliers as early as possible. Some great companies take time to develop. And the non-consensus investments might not be obvious for quite some time.

/4

In fact, one LP remarked to me that there was pretty good data that the relative performance of an early stage fund in the first five years of life had almost no correlation to their ultimate performance. This was pretty surprising 👀

/5

This has proven to be true of our early funds. NextView I and II are both fairly mature, have distributed lots of capital back to LPs’, and has exceeded expectations and benchmarks. But this was not clear in the first 3-5 years.

/6

Some of the best investments in that fund were non-obvious for quite some time. Some had fairly late value inflection points (eg: @Whoop). Some built profitably, so never got marked up by a new round (eg: @triplelift)

/7

Conversely, I can point to dozens of companies that screamed out of the gate and then flamed out. VC's raised billions on the back of these “results”.

/8

But today, with the market as strong as it is (ignoring the recent pullback 😬) the emphasis on short-term markups is stronger than ever. When everyone has strong short-term metrics, even if they don't really matter, you feel the need to keep up.

/9

The positive is that it’s harder to fake it as a new fund. You need to put up numbers, which is good accountability. Also, as the market is more efficient, quality companies scale quickly and value inflection points are steeper. So this sort of makes sense.

/10

But there are downsides.

First: Less independent thinking. Focusing on near-term markups means piling into markets that you know are hot and looking for qualities that you know others will value. Not good ingredients for contrarian thinking 🙃

/11

Second: Less incentive to invest in really early or unproven teams. Searching for PMF takes time, and in this market, investing in early traction gets rewarded much more quickly.

/12

Third: premature scaling and capital raising. Funds can’t mark up an investment unless a new round happens. So VC’s are incentivized to encourage founders to raise because they can, not because they are ready.

/13

Fourth: I’ve seen investors just lose interest if a company has a slow start. This totally sucks and is massively demoralizing for founders. These same investors will then demand their full pro-rata rights if things change and a fancy round comes together down the road 🤯

/14

So, overall, I’m skeptical 🤔. Early marks are comforting, but focusing on them too much has a lot of negative repercussions for founders and the market. Early stage investors should focus on building long-term value.

/15

Founders should be wary of investors that seem too focused on short-term marks. Instead, steer towards investors that are non-anxious and are committed to building with you for the long term.

/16

The best investors I’ve seen are patient and are willing to look foolish 🤡 for quite some time. They are rewarded by years of quiet compounding, which leads to legendary companies. That is way better than a quick markup 😀

/End