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Right-sizing a VC fund

In my previous post on entrepreneurship in Massachusetts, I discussed the lack of 'anchor tenants' in the MA high-tech sector.  Another issue in Massachusetts and the rest of the industry has to do with the mismatch between the desired capital efficiency of a start-up and the ever increasing size of most venture funds.  It's very hard for a big fund to invest in an early stage company that may not require very much capital and may only produce a modest total outcome (although a nice multiple on invested capital).

This issue was also recently discussed on Venture Beat by Charles Moldow of Foundation Capital.  I agree with his analysis.  I think that there is an opportunity for small to medium size venture funds ($70-120M) with 3-5 partners.  Funds of this size can make investments in companies that do not require too much capital (maybe $6M from one of these funds over the life of a deal, perhaps two of these funds in the deal all the way through).  With this amount of capital, a $100M exit is a nice win.  If the amount of capital is moderated a bit with frugality, the average $72M exit on a total of $8M invested is also a very nice return.  Exits of this size can move the needle on a modest size fund, but don't get the attention of a bigger fund.

I think that there is an opportunity for funds of this size, and there are some existing and new funds which are targeting this market segment.  Venture fund limited partners are also starting to notice that they should look to smaller funds who can deliver a nice multiple on their money.  The challenge is that there is a lot of money in LP pockets, which tends to force up fund sizes (and push these types of investments out of the sweet spot).

There are other factors which have forced VC fund sizes and exist expectations so high.  I'll write about those in the future.

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