The Perils of Virtue Scanning...

Recently, I was on a call with a founder who I like and who is building an important business in the care economy. She was equally excited to talk to me because she concluded that Fairbridge Park was a patient investor given the “mission-driven nature” of our portfolio companies. Her conclusion is a common misconception. Founders can mistakenly attribute virtues — patience, founder-friendliness, fairness etc. — to funds with cause-based mandates — a focus on minorities and women, social impact etc. This attribution is problematic for two reasons:
(i) Funds with such virtuous mandates generally have more constraints, which usually renders them less flexible, and
(ii) People are more what they do vs. what they say.

In this letter, I will shed some light on a framework founders can apply to determine if an investment firm and its members are truly patient.

Legal Structures

The easiest indicator for patience is if it’s embedded in a fund’s business model. Founders can research this information in public filings or through direct inquiry.

Evergreen Funds: Some funds are organized legally as evergreen, enabling them to invest in the same company across multiple stages. General Atlantic is a good example. Evergreen funds are often a privilege afforded to managers by LPs after a long track record of trust and success. This means the bar for receiving investment is relatively high.
Multistage Funds: Some funds run a multistage investment strategy. They raise distinct funds for different investments stages under one umbrella brand. Under this strategy a growth-stage fund can invest in a portfolio company of its early-stage, sister fund. Fin Capital and Susa Ventures are good examples. Understanding the nuances of how a company qualifies for investment from a sister fund is critical.
Family Offices: Some Family Offices have created evergreen funds to achieve a clean separation of balance sheets and economics between their asset management and operating businesses. Family Offices might not disclose this information publicly, so please ask.

Technical Considerations

Additionally, technical hurdles such as investment philosophy, timing, and LP restrictions, dictate a fund’s ability to invest in future rounds.

Portfolio Construction: Early stage investors broadly manage opportunity cost in two ways. Some believe in chasing winners by investing in subsequent rounds to build a concentrated portfolio. Others believe in highly diversified portfolios. They believe that taking as many swings as possible at the bat increases likelihood for homeruns. Homeruns matter to the Power Laws of venture capital. Capital budgeting can also be impacted by the size of the fund. Smaller funds seeking an appropriate level of diversification will not have the capacity to double down.
Timing: A fund in its fourth year of a 5-year investment period will likely be unable to invest in a follow-on round because of time constraints.
New Fund Rules: LPs often do not allow funds to comingle, so even if your investor group raises a new fund that you are eligible for in principle, they still can’t invest because of conflict of interest.

Behavior

Patience is a practice. Investigating past behavior that demonstrates an investor’s patience is important. Has your investor participated in a bridge round to assist a portfolio company? What are concrete examples of support from portfolio companies?

Values: There are fund managers with core values of loyalty and steadfastness. They generally stick with companies through challenging times. Union Square Ventures for example is known for spending most of the time with companies that are underperforming vs. a general practice of focusing on winners. Altos Ventures believes that most rewards come at the end, and they stick with companies over extended periods of time like they did with Roblox. They have been known to even raise SPVs when their funds couldn’t invest.
Track Record: Investors with prior success are trusted by their LPs and peers to do it again. They are not under pressure to prove a point and can navigate choppy waters with poise.
Subject Matter Expertise: Investors with a grounding in technical fundamentals of a business can withstand deviation from comps. They understand the intrinsic value of a business without having to connect it to outputs like revenue.

The Takeaway

It’s careless to take what investors say about their organizations’ character at face value. Criteria based on virtue generally create more constraints, and perhaps put some extra burden of proof on investors carrying those mandates. This results in inflexibility towards founders. Furthermore, founders might completely miss relevant investors who decide against headlining with virtue. Good news!!! Founders can perform sound due diligence using ample, accessible resources to understand investor’s true capacity and tendency for patience.