Understanding Your Investors

To some extent, this blog has been about demystifying venture capital and in particular me and the firm I work at, USV.

There are many reasons why I think that is a useful exercise. When I got into the VC business in the mid 80s, it was a fairly opaque business and that did not change a lot over the next 15 years. When the Internet came along, it promised more transparency and I thought that using the Internet to help facilitate more understanding about VC was a good idea.

But also it was, and is, a self interested move. I believe that entrepreneurs are more likely to take money from a firm that they feel like they know, like, and trust. And in the hyper-competitive world of startup finance, being an open book can pay huge dividends. We have seen that to be true again and again.

So understanding your investors is important and reading VC blogs is a good way to increase your understanding of the people who may invest or have invested in your company.

One area that entrepreneurs should take some time to understand is the way that VC funds are structured. The economic terms (management fee and carry) and the durability of the capital (investment period, fund life) are particularly important as they will influence the behavior of your investors.

I have written a fair bit about these issues here at AVC as have others like Brad Feld.

One area where fund structures are different is in the crypto sector. Because crypto tokens become liquid much more quickly than startup equity, and because investors in the crypto sector will want to own publicly traded crypto tokens, the hedge fund model has been adopted by many of the investors in the crypto sector.

Joel Monegro, co-founder of Placeholder.vc and a former USV team member, wrote a good crisp comparison of the venture fund model and the hedge fund model on the Placeholder blog yesterday. USV is an investor in Placeholder.

Joel writes:

The effect of these differences is that hedge fund managers have a greater incentive to maximize short-term profits, as they can be severely affected if the fund underperforms in any given period, while VCs are incentivized to maximize long-term, realized value in order to increase their payout. And this is reflected in how each type seeks profits: in general, hedge funds will tend to trade around market fluctuations, while venture funds tend to build and hold investments to optimize for long-term value.

USV has invested in a half a dozen token funds, often as an initial LP to help the fund get going, and most of the funds we are invested in use the hedge fund model. Placeholder uses a VC model.

So we don’t have a strong point of view about which approach is best. Certainly in terms of maximizing our liquidity, the hedge fund model is best. But for entrepreneurs who want patient stable capital, it may be true that the VC fund model is preferable.

This is something to watch over the next five to ten years as this sector matures and we learn about which structure is preferable for entrepreneurs, fund managers, and fund investors.

We already see hybrid models emerging where a hedge fund structure is used but long lockups are required for investors. It will be interesting to see if the way management fees and carry payouts will evolve as well.

One thing is for sure. Entrepreneurs need to understand how the capital they are taking into their company is structured and what expectations and requirements the suppliers of that capital have negotiated with the fund managers. If you aren’t asking those questions of your investors, you should be.


Comments (Archived):

  1. William Mougayar

    The hybrid model is interesting, but there is little history behind it, and it is a bit more tricky to administer, given there will be liquid and non-liquid pockets. And if you take too much capital upfront but don’t deploy it, it will mess up your IRR.I’ve said it before- it is too early to have so many crypto hedge funds given the immature cycle we’re in for that industry. LP’s can call their capital every quarter, causing selling pressure on the markets which causes prices to go down, without any logic behind it. That was a factor that caused crypto prices to go down last year.Crypto hedge funds are momentum chasers. That works well as long as the momentum keeps going, but that’s not always the case.

    1. Chris Harvey

      Yes, not to mention the legal difficulties in allowing redemption rights and non-qualifying assets in your venture capital fund (which current law prohibits both as a venture capital fund). You can be a hedge fund with those features but it comes at the cost of regulatory disclosures and oversight.

      1. William Mougayar


  2. kidmercury

    what I think a lot of token entrepreneurs will need are fund managers who are willing to help defend price levels of their tokens; basically, declaring s price they will buy at, which in turn can boost stability in price and a gradual ascent in it’s rise. I think this might be the cryptocurrency version of open market operations utililized by nation state central banks.

    1. RiganoESQ

      was thinking something similar … which is a strange thing to have written in an investment agreement … would be most efficient if it was baked into the crypo-economics of the token.also one point this post seems to miss is the assumption the an entrepreneur will have the option of fast $ v long term $ … most dont really have any option and will take whatever is given to them, which can cause significant issues.

  3. Andrew Cashion

    It’s 2025.Series A rounds are way down.Late stage investment rounds are thin.There is a massive crypto bubble.Idiots are making millions.Jameshrh missed all crypto investments and is currently bagging my groceries.JK.

    1. JamesHRH

      Well, trust me, I haven’t bagged groceries since I worked at Tallon’s Family Grocery in Waskesiu Lake, P.A.N.P in 1980. And, I wouldn’t trade that job experience for anything, mostly for because of the view(s) we had all summer (beach, lake, young tourists stocking up for the aforementioned) & not the $4.25 / hr minimum wage.And my current financial state has me feeling quite confident that I won’t be bagging it for you or anyone else any time soon.Mind you, if I got into crypto I just might to need to, being a non-believer in coins as an economic force or Blockchains as a unifying technology that creates dominant market positions & great wealth).I am, however, thinking about buying land in Inuvik ( https://www.inuvik.ca/en/in… ) though, which is going to be a growth market post climate apocalypse. I had a great article / interactive map that was based on the earth heating up, the middle becoming useless and the top&bottom becoming, well, the place to be (not frozen wastelands, obviously). No can find.If the Inuvik play doesn’t come together, I might be baggings groceries, but it will probably be there and so, likely not for you!I am less of a crypto skeptic that you think – this is my futurism bible after all ( https://www.publishersweekl… ). Re-reading it as we speak. And I CANNOT STAND futurists. These dudes (well dude, it is Watts Wacker that did the insanely rigorous observations) are the best.Here is the money quote from the review:”They note that massive societal shifts occur at 500-year intervals (e.g., the collapse of feudalism). Accordingly, the end of this particular millennium signals another such period. The world is switching from a society based on reason to one based on chaos, where political and social institutions are splintering, and product-based consumer markets are collapsing. These three great streams of change are converging to form the delta of the title. “Read that twice and then tell me how you feel about the current state of the cutting edge cultures in western democracies. All the things that hold the centre (reason over feels, church/state/family & consumer tribes ) are losing their hold.

      1. Andrew Cashion

        For fuck sakes you’ve been getting soft James.I read it more than twice, however the blip on the publishers weekly page seemed quacky. No offense. The kind of VC bullshit I can’t stand. “At the turn of the century X pattern happen and now X pattern is happening.”This time 5 Fucking centuries.I bussed tables as second job once, very fun, great view of the cape fear river. A great time in my life.As for the current state of cutting edge cultures in western democracies?What will happen to Unions?There is always a vein of contradiction.

        1. JamesHRH

          You seem to have lost your jovial mood AC.500 Year Delta is interesting for this reason: economies & warfare tech have long epochs.1000-1500: farming : horse&steel.1500-2000: industrial productions : ballistics ( bullets / bombs ).2000-2500: information : ?The predictions in the book are coming true: eroding dominance of reason; eroding trust in societal institutions ( politics, Catholic Church anyone?); eroding internet in consumption of goods.

          1. Andrew Cashion

            I’ll check it out.I think that the consumption of goods is expanding the internet.Ultimate inflection point incoming for sure.I understand the construct of your argument from the book. It’s all to easy to view the book from a millennial bias as, ” no church no family- limited future consumer products already been created type of thing.”I will say the ballistics concepts is intriguing in the sense that it is old physics warfare still being used.Will China skip creating a navy and go pure internet tech warefare? I doubt it.As to my jovialness- I’ve been working 7 days a week. Got a new job and my psychology is changing. Trying to get my humor going.

          2. JamesHRH

            Most futurism is bunk.These themes make some sense to me. The world is smaller and resources are finite.AS well, the leading edge of society – US, western Europe – is close to a matriarchal revolution. My son is bullied at our private school, but not by threat or physical violence, but by boys ostracizing him and popular boys approving of the smear campaign tactic (i.e., the culture is not ‘strong and smart rule’ but ‘looking popular and managing image best rule’.Or, as I have heard my daughter’s 16 year old group of girls say ‘He’s such a little bitch.’Ground level change / evolution in western culture.

          3. Andrew Cashion

            The bullying thing I haven’t experienced except back in the day in high school using AIM instant Messager. More harassment than bullying I’d say.Having been dubbed street smart before I bacame book smart. I was then dubbed book smart and no longer street smart.The world is smaller, in fact a friend I work with is in Europe right now Denmark. He spends his money traveling. Somewhat different than going to a concert of somewhere closer. I attribute it to smartphones directly in this case. He is going to visit a girlfriend there. A long way for a date.

  4. LIAD

    Was literally reading the placeholder post as the AVC post notification referencing it popped up.https://uploads.disquscdn.c

  5. JLM

    .The single most important decision we ever make in business is with whom we are going to do business.A bad co-founder, a bad senior hire, a bad VC can wreck any idea.It takes time to get to know people and you have to be quiet to listen to who they are and why.Freddie does himself, his partners, his firm, and his LPs a service by de-mystifying who he is (one may cynically think: projecting the image he wants to project). This makes the typical 7-touch process of raising $$$ less intimidating.JLMwww.themusingsofthebigredca…

    1. sigmaalgebra

      > A bad co-founder, a bad senior hire, a bad VC can wreck any idea.Darned right! Throw one stone and kill all three bad birds — be a sole, solo founder, do all the work, self-fund, and bootstrap.

  6. Stephen DeWitt

    So true. I’ve raised a lot of $ from many of the leading VC firms thru the years. A partnership that is transparent, informed and collaborative between all simply yields better results. As important as anything else.

  7. Mario Cantin

    I long for a return to where the small investor can directly invest into a new token (if there was a clear regulatory path for that). I’ve looked into investing in Difinity, Kadena, Solana, et al; but no joy — you largely need to be a VC or a fund. I suppose protecting the small investor comes at the cost of holding back the methodical, smart small investor.

    1. Adam Sher

      Couldn’t you structure an ICO under Reg CF and accept retail investors? Protecting small investors always felt like the result of lobbying. In real estate and VC, there are companies like Patch of Land and SeedInvest that allow retail under Reg CF. SeedInvest and Equity.Indiegogo offer investments in blockchain tech. I’m not sure if they show any ICOs.As long as a casino and onlineo gambling is legal to retail, the SEC isn’t protecting retail from anything. To this point, Robinhood provides “free” trading. Now there’s no barrier (previously $13/trade at E-Trade) to losing your money to day trading.

      1. Mario Cantin

        I’m not sure about the answer to your question, but I love your observation about casino gambling.

        1. Adam Sher

          FOMO for losing money.

        2. Adam Sher

          I’m confident the answer is yes in a lot of cases. I have an accounting/tax CPE on it in March. Check with me then!

      2. JamesHRH

        Of all places, I saw Mark Cuban on Shark Tank ( I have no idea why I occsssionally watch 1/3 of an episode ) toast a SV RE startup that was on this theme.One word – ‘liquidity’.ICOs wouldn’t have that problem.

        1. Adam Sher

          Sure, that’s true in theory. How many tokens will continue to have liquidity v exhibit pink sheet like behavior where it becomes more difficult to trade?

          1. JamesHRH

            Totally agree. Zombie coins.

  8. JamesHRH

    5-10 years to see how crypto settles out. Hmmmm.Darpanet / internet dates from 1972. Let’s say the GUI & browser & fibre are needed to reach lift off. So, Web Year 1 is 1998 & today is Web Year 21. Deal?With the web in place for when Satoshi spawns Bitcoin, that’s a lot of heavy lifting done. So, Blockchain Year 1 is 2010 making today Blockchain Year 9. Deal?What will be different in 20 A.B. / 42 A.W. / 2039 A.D.?Also, the hedge fund model always seemed a mug’s game to me:Year 1, up 400%, smoke the 20% carry for 80% of the total funds originally committed.Year 2, down 75-80%, now at 100% of original funding but investors have paid out 80% in fees (+ mgmt fees) for 0% growth over two years.Very, very Wall St.

  9. Jacek

    Business development very often depends on capital. Often a very large capital is why IT projects are so expensive. https://www.gmihub.com/blog… Therefore, it is worth considering the use of VC services in advance. And prepare well for such a conversation.

  10. Chris Harvey

    Great article but can we focus on the regulatory definition of a “venture capital fund” for a moment?Qualifying as a “venture capital fund” comes with benefits like fewer reporting guidelines than other types of private investment funds, but the definition of a VC fund precludes almost all crypto VC investment structures.Venture capital funds are defined, in relevant part, as a fund that pursues a venture capital strategy with no more than 20% of committed capital in non-qualifying investments (i.e., not equity securities) with no redemption rights to the fund’s LPs, except in extraordinary circumstances.Importantly, almost all digital tokens and digital assets are not considered part of the 80% of qualifying investments, since tokens are not generally considered equity securities. Which means that a fund that focuses solely on digital assets will not qualify as a venture capital fund as that definition currently exists.Of course, the National Venture Capital Association (NVCA) is asking for more flexibility, arguing that current rules are antiquated — particularly as companies stay private longer, and desire liquidity solution for founders and early employees.It also argues that digital tokens should be included within the 80%, because it shouldn’t matter if a fund invests in a startup through preferred equity or a digital token. The NCVA also wants cryptocurrencies like Bitcoin and Ether to be considered “cash equivalents,” which VC funds may hold without limit, for purposes of Section 203(l) of the Investment Company Act (15. U.S.C. 80b-3(l)).For more information on this topic please see, https://www.axios.com/vc-lo

  11. Chris Adamo

    we’re always looking for aligned investors and lead with putting all of our cards up on the table. If the investor-investee mission alignment isn’t there, then it’s a pass