20 VC 093 Where Is The Micro VC Market Going with Samir Kaji @ First Republic Bank

In this episode of the 20 Minutes VC, host Harry Stebbings interviews Samir Kaji, Managing Director at First Republic Bank, about the burgeoning micro VC landscape. Samir, with over a decade of experience in venture capital and private equity banking, shares his journey from selling vacuum cleaners to becoming a VC expert. He discusses the characteristics of micro VC firms, such as their sub-$100 million funds and seed stage investment focus, and contrasts their collegial nature with traditional VC firms. Samir also addresses the challenges of living off management fees for smaller funds and the potential for a shift towards higher carry models. The conversation delves into the drivers behind the micro VC sector's growth, including the efficiency of capital in startups and the attractive returns of smaller funds. Samir predicts a future contraction in the number of active micro VCs, an increased role for platforms like AngelList, and a greater reliance on data for investment decisions. He respects pioneers like Mike Maples and Jeff Clavier for shaping the micro VC industry and emphasizes the importance of staying humble and focused on aiding the innovation economy.

• Harry Stebbings introduces the topic of the day: an overview of the micro VC industry, its growth, trends, sectors, and the future of seed funding.
• Samir Kaji, an industry expert on micro VC, is introduced as the guest.
• Samir has extensive experience in banking with venture capital and private equity clients, and currently works at First Republic Bank.

"Today we will have an overview of the microvc industry. Look at what's driving the immense growth of microvC, the emerging trends and sectors, and then the future of seed funding."

The quote sets the stage for the podcast's focus on exploring the micro VC landscape, its evolution, and its impact on seed funding.

• Samir shares his serendipitous entry into the VC and tech world, starting at Silicon Valley Bank.
• He reflects on the challenging early years during the tech bubble burst and how those experiences shaped his career.
• Samir's move to First Republic Bank was motivated by his focus on early-stage VC and tech companies.

"So about 16 years ago, I started at a bank called Silicon Valley bank... And I went on my school's job track system and the first posting was Silicon Valley Bank."

Samir's career in venture capital began with an unexpected opportunity at Silicon Valley Bank, marking the start of his journey in the industry.

• Samir spent 13 years at Silicon Valley Bank, working with technology companies and venture debt.
• He transitioned to the venture group at Silicon Valley Bank post the 2008 financial crisis.
• Samir's move to First Republic Bank was a strategic career step to focus on early-stage VC and tech.

"I moved to the venture group at Silicon Valley bank, did that for about four years, and then decided to make the move to First Republic along with a few other Silicon Valley bank employees."

The quote explains Samir's career progression, leading to his current role at First Republic Bank where he specializes in early-stage venture capital.

• Samir is not a fan of the term "micro VC" but uses it for the purpose of the interview.
• Micro VCs are characterized by having funds under $100 million, small teams, and a focus on seed-stage investments.
• Micro VC General Partners (GPs) are noted for being collegial and entrepreneurial, differentiating them from traditional VCs.

"Common characteristics of what people consider micro vcs or firms that are raising funds that are sub $100 million, typically 25 to 50, no more than about three partners, usually one or two, and fundamentally are focused on investing in the seed stage."

This quote defines micro VC firms by their fund size, team size, and investment focus, providing a basic understanding of what constitutes a micro VC.

• Samir addresses the challenge of micro VCs generating sufficient management fees to support the partners.
• He notes that many GPs may have pre-existing wealth, allowing them to focus on the carry rather than management fees.
• The goal is to align interests with Limited Partners (LPs) and establish a track record for future, larger funds.

"Well, it's not. I mean, if you think about a ten or $15 million fund that's putting out three to $400,000 in fees, especially in certain markets, the Bay Area, New York, it's impossible to live."

Samir candidly discusses the financial realities of running a small micro VC fund, highlighting the inadequacy of management fees to sustain partners in high-cost living areas.

• Micro VC funds often start with drawing fees from multiple funds to sustain operations.
• Management fees typically range between two and two and a half percent.
• Some micro VC firms are moving towards higher carried interest (carry) models.
• There's a possibility of seeing funds with lower management fees and higher carry, potentially based on performance metrics.

"But originally it's very tough to live up those fees."

This quote highlights the initial financial challenges micro VC funds face in sustaining operations solely on management fees.

"I do think we will start to see some that are more carry focused. I don't know if we'll get to 0%, but I think we will see some firms raise funds where it's more of like a one in 25, a one in 30, and perhaps even higher carry based on hitting some performance metrics."

Samir Kaji predicts a trend towards higher carry in compensation structures for micro VC firms, with performance metrics possibly influencing the carry percentage.

• There has been an exponential increase in the number of micro VC firms globally.
• Capital efficiency of startups has significantly improved, making smaller investments more impactful.
• Historical venture industry performance was poor, leading to a reevaluation of fund sizes.
• Smaller funds have been shown to potentially yield higher returns than larger funds.

"Today there's close to 300 globally, of which 225 are here in the US, and there's another 50 to 100 that are fundraising."

Samir Kaji provides statistics to illustrate the rapid growth of micro VC firms, particularly in the US.

"Today, startups can get off the ground at one 100th of the cost of what they had to sort of encounter back in 99 or 2000."

Samir Kaji explains that reduced startup costs have made micro VCs viable by allowing them to build diversified portfolios with smaller checks.

"Kaufman Fellows did a great report evidencing that smaller funds tend to outpace the returns of larger funds."

Samir Kaji references a report that supports the idea that smaller funds can outperform larger ones, which has contributed to the popularity of micro VC funds.

• Smaller funds have a mathematical advantage over larger funds in achieving target returns.
• The barriers to entry for raising a micro VC fund are lower than for larger funds.
• Interest rates have remained low, making venture capital an attractive investment for yield.

"It's purely a math thing, and it's purely the fact that there's only a few really game changing exits that happen per year."

Samir Kaji attributes the success of smaller funds to the simple math of required returns and the limited number of significant exits available each year.

"Raising a $25 million fund is far different than raising a half a billion dollar fund."

Samir Kaji contrasts the fundraising process for micro VC funds with that of larger funds, highlighting the ease of raising smaller funds from personal networks and individual investors.

• The growth in micro VC funds provides more funding sources for early-stage companies.
• There is a concern that only a small percentage of micro VC firms will meet LPs' return expectations.
• The positive impact on the innovation economy outweighs potential negatives of too much capital.

"I think a very few percentage of these micro firms are going to produce the type of returns expected."

Samir Kaji acknowledges that many micro VC firms may not achieve the high returns expected by their LPs.

"You sort of noted that there are more funding sources for these early stage companies of all types and sizes to be able to leverage early institutional capital."

Samir Kaji emphasizes the benefit of having more funding sources for startups, which supports the broader innovation economy.

• LPs in micro VC funds may have different profiles compared to those in traditional venture funds.

"And lps for these micro VC funds, are they fundamentally very different to the traditional lps for normal venture funds?"

Harry Stebbings questions whether the investor base for micro VC funds differs significantly from that of traditional venture funds, implying that micro VC funds may attract a more diverse range of investors.

• Traditional venture firms are primarily backed by pension funds, endowments, fund of funds, and foundations.
• Micro VC firms, especially those with funds of $25 million and under, are mainly backed by family offices and high net worth individuals.
• Funds of $30 million and above usually have one or two institutional investors, like a fund of funds or a small endowment.

"Most of the micro VC firms and about 48% are 25 and under in size. Those typically have no endowments, have no pension funds, very rarely have any sort of institutional backing, but are primarily family office high net worth backed."

This quote explains the funding structure of micro VC firms, highlighting the lack of traditional institutional investors and the reliance on family offices and high net worth individuals for smaller funds.

• There is a significant amount of capital at the seed stage and at the late growth stage.
• C and D series funding stages have fewer investors and a gap exists in this segment.
• Valuations at the B and C stages are not as inflated compared to the seed stage and very late growth stages.
• Opportunities exist at the C and D levels where companies have strong growth metrics but have not seen massive valuation increases.

"I think there's opportunities at that c and D level where we have companies that have hit product market fit or in scale mode have great growth metrics, but haven't seen massive upticks in valuation."

The quote identifies a funding gap and potential investment opportunities in the C and D series funding stages, where companies have proven their market fit and are scaling but have not yet experienced significant valuation increases.

• The amount of capital on AngelList is still relatively low but is increasing.
• AngelList is beneficial for very early-stage companies to raise initial funding.
• The platform may play a more significant role across all investment cycles in the future, not just seed.
• The investment pattern on AngelList may not be linear, with "tourist investors" likely to retract in market downturns.
• AngelList is seen as complementary to venture capital rather than a disruptor.
• Smaller proof of concept funds may opt for AngelList over standalone LP funds due to the ease of raising and administering funds.

"I actually do think that Angeles is going to play a more prominent role across all cycles, not just the seed cycle, but I think it's going to be in fits and spurts."

This quote suggests that AngelList's influence on the investment landscape will grow, impacting various stages of the funding cycle, though the growth may be irregular.

• There is a bifurcation in the micro VC market with nearly half of the firms managing funds of $25 million and under.
• These smaller funds often participate as part of a syndicate and do not lead rounds.
• Larger, first-generation micro VC firms are beginning to resemble full-stack VCs, leading rounds and investing across multiple stages.
• Differentiation among micro VC firms is increasingly achieved through thematic and vertical focuses, moving away from the generalist approach.

"Now we're seeing funds that are very focused on certain segments, whether it be b to b, whether it be consumer, whether it be IoT robotics."

The quote highlights the shift towards specialization in the micro VC market, with funds increasingly focusing on specific sectors to offer unique value to entrepreneurs.

• Expectations include a contraction in the number of active micro VC firms to 100-150 by 2020.
• This prediction is based on the mathematics of returns and sustainability within the industry.
• Historical patterns show a similar contraction in the number of active venture funds after a peak.

"The number of active micro vcs, I think is going to drop to close to 100 to 150 by the year 2020."

This quote provides a forecast for the seed funding environment, predicting a significant reduction in the number of active micro VC firms due to the sustainability of returns within the market.

• Contraction in the seed ecosystem is anticipated.
• Platforms like AngelList will continue to gain prominence, despite potential retractions.
• Data utilization is increasing, with firms like Signalfire using proprietary data platforms for decision-making.
• Mattermark and CB Insights are highlighted for their work in making private data actionable.

"Fundamentally we saw a massive contraction. I think that's going to happen."

This quote emphasizes the expectation of a downturn or contraction within the seed investment ecosystem.

"I think another thing that's going to happen is the continued prominence of platforms like angel list."

Samir Kaji predicts the ongoing rise of investment platforms such as AngelList in the seed funding landscape.

"And the third thing I think we're going to see, we're starting to see this to a certain level is the use of data."

Samir Kaji discusses the growing trend of using data to inform investment decisions in the seed stage.

• Samir Kaji enjoys a Phil Jackson book about managing a team with strong personalities.
• From a business perspective, he recommends "Give and Take" by Adam Grant for its insights into behavioral psychology.
• David Hornick from August Capital also regards "Give and Take" as a favorite book.

"And so the Phil Jackson book to me is really interesting in terms of behavioral know, running a team with a lot of egos and actually being successful throughout this."

This quote reflects Samir Kaji's interest in team dynamics and leadership, particularly in challenging environments with strong egos.

"It's a great book. It's a great book. And for anyone that has. It's an easy read. For anyone that has a little bit of time, it's a must have in terms of anyone that's interacting with people."

Samir Kaji endorses "Give and Take" by Adam Grant as a valuable and accessible read for those interested in social interactions and behavior.

• Samir Kaji respects pioneers of the micro VC industry, such as Mike Maples, Michael Daring, Steve Anderson, and Jeff Clavier.
• He also values VCs who have an authentic desire to support the innovation community and maintain humility.

"I really respect the pioneers of this industry, the ones that first took the know folks like Mike Maples and Michael Daring, Steve Anderson, Jeff Clavier, they started the micro VC trend and they started raising these small funds when it wasn't even a thought."

The quote acknowledges the early innovators who shaped the micro VC industry by starting small venture funds.

"I respect any VC, any micro VC that fundamentally has an authentic desire to help the innovation community and stays humble about it."

Samir Kaji expresses admiration for VCs who genuinely aim to contribute to the innovation ecosystem while remaining humble.

• Samir Kaji suggests spending 20 minutes reading each morning, self-reflecting for an hour a week, and dedicating 2 hours daily to disconnect and spend time with loved ones.
• These habits contribute to personal growth, strategic thinking, and maintaining work-life balance.

"Number one is every morning spend 20 minutes just reading."

This quote highlights the importance of dedicating time to reading as a way to start the day informed and engaged.

"I think you have to spend an hour a week self reflecting."

Samir Kaji advocates for regular self-reflection as a means of challenging one's thoughts and enhancing career development.

"And then the third one, which I'm not good at, is carving out 2 hours a day where you're just not connecting, you're spending time with family and friends."

The quote underlines the challenge and importance of unplugging from work to nurture personal relationships.

• Samir Kaji enjoys content from Fortune's Strictly VC and bloggers like Thomas from Redpoint and Brad Feld.
• He appreciates the authenticity and thoughtfulness of writers like Ezra Galston from Chicago Ventures.

"I'm a big fan of fortune. Strictly VC."

Samir Kaji expresses his preference for Fortune's Strictly VC as a valuable source of information.

"There's also some young and up and comer folks, like Ezra Galston from Chicago Ventures."

The quote recognizes the insightful contributions of newer voices in the industry, such as Ezra Galston.

• Returning capital to investors is identified as the most challenging aspect of being a VC.
• The difficulty lies not only in achieving returns but also in the long time frame required to evaluate investment success.

"Yeah, it's returning capital. It's incredibly tough thing to do."

Samir Kaji points out that generating returns for investors is one of the hardest parts of venture capital.

"And until cash hits the bank, it's not there."

This quote emphasizes that until returns are realized in a tangible form, they cannot be counted as successful investments.

"I know people that are incredible fundraisers but are terrible at actually distributing capital back."

Samir Kaji notes that there is a distinction between the ability to raise funds and the ability to generate and return profits from those funds.