20VC Semil Shah on The Biggest Mistakes VCs and LPs Made Over the Last 24 Months, Why LP Churn is Coming, Core Lessons on Scaling from $1M Haystack Fund I to Today and How To Find, Win and Manage LPs as an Emerging Manager



Harry Stebbings interviews Semil Shah, the founder of Haystack, on the 20vc podcast, where they discuss Shah's investment philosophy and the successes and challenges of his venture firm. Shah's Haystack has had notable investments in DoorDash, Instacart, and Opendoor, with its first fund marked between 30 to 40x. They delve into the importance of respecting investment dollars, the wisdom of doing good deals (DGD), and the necessity for founders to provide transparent updates to investors. Semil Shah also reflects on missed opportunities, such as OpenSea, emphasizing the importance of understanding and acting on what is working. The conversation covers LPs' role in fund size escalation, the potential need for portfolio markdowns in response to market conditions, and the Darwinian nature of the current investment landscape. They also touch on the value of building relationships with LPs outside of fundraising cycles and the potential misalignment of incentives within the LP community.

Summary Notes

Investment Success Story: Hashicorp

  • Semil Shah invested in Hashicorp's first round, turning a $25,000 investment into approximately $30-35 million.
  • The significant return on investment highlights the potential of early-stage venture capital.

"Hashicorp where we invested in the first round and that was just a huge win. I think it was like the 25k turned into something like 30 35 million buck."

This quote emphasizes the magnitude of the successful investment and the substantial financial return achieved from the initial $25,000 investment.

Haystack's Investment Portfolio and Performance

  • Semil Shah is the founder of Haystack, a leading pre-seed and seed firm.
  • Haystack's portfolio includes companies like Doordash, Instacart, Opendoor, Figma, and Carter.
  • The first fund is marked between a 30 and a 40x return.

"Among Semel's incredible portfolio is Doordash, Instacart, Opendoor, Figma, Carter and many more."

This quote lists some of the successful investments made by Haystack, showcasing the firm's track record in identifying and supporting high-growth companies.

Harvard Management Company (HMC) and Venture Capital

  • HMC manages Harvard University's endowment and was an early institutional investor in venture capital.
  • HMC seeks to partner with new and established fund managers, offering insights and support for success.

"Harvard Management Company is constantly seeking out the next generation of great investors and entrepreneurs."

This quote highlights HMC's commitment to nurturing new talent in the investment world and its long-standing presence in the venture capital ecosystem.

Mercury and MarketX: Startup and Investment Support

  • Mercury provides banking services tailored for startups, including FDIC insured accounts and various financial tools.
  • MarketX offers a platform for investing in pre-IPO technology companies and allows investors to create their own syndicates.

"Mercury is building full stack banking for startups."

This quote underscores Mercury's role in providing comprehensive financial services designed to meet the specific needs of startups.

Professional Fears and Aspirations

  • Semil Shah discusses his fear of not being able to continue participating in the Bay Area's ecosystem.
  • He aspires to become an investor of record, surprising people with his involvement in important companies.

"What I'm running from is just the fear of not being able to participate in the way I want to in the ecosystem."

This quote reflects Semil Shah's concern about maintaining his role and influence within the competitive Bay Area investment landscape.

Fund Sizing Decisions for Haystack

  • Early funds were undersubscribed, but recent funds were set at $50 million to maintain an effective investment strategy.
  • The fund size enables Haystack to achieve desired ownership percentages in pre-seed and seed rounds.
  • The strategy aims for simplicity and repeatability, avoiding overcomplication.

"For the last two, they were just marked at 50."

This quote explains the rationale behind Haystack's decision to maintain a $50 million fund size, which aligns with their investment strategy and objectives.

Pre-seed and Seed Round Dynamics

  • Pre-seed and seed round valuations have increased over time, with $3 million on a $15 million valuation becoming a median entry point.
  • Haystack's strategy is to keep funds under $100 million to avoid dilution and maintain significant ownership at exit.

"I think there are classes around."

This quote leads into a discussion on the evolving nature of pre-seed and seed rounds and the changing expectations for valuation and investment.

Talent Versus Entrepreneurialism

  • Semil Shah believes that not all talented individuals are entrepreneurial and that true entrepreneurs have shown some form of hustle or grit in their past.
  • He looks for evidence of overcoming adversity and passion in potential investees.

"Are talented people also entrepreneurial? And I don't believe that."

This quote conveys the idea that talent alone does not equate to entrepreneurial success, and that other qualities are necessary for a successful founder.

Leading Versus Participating in Deals

  • Haystack leads a select number of deals but is also willing to take a supporting role.
  • This flexibility allows them to work with entrepreneurs they believe in and maintain a high-quality portfolio.

"We can sit in the driver's seat and lead the deal. We can sit in the passenger seat and be a co lead, or the second biggest check, or we can be in the backseat as the third check."

This quote explains Haystack's adaptable approach to investment, which allows them to play different roles depending on the deal and the needs of the entrepreneur.

Investment Philosophy and Strategy

  • Semil Shah emphasizes the importance of speed and conviction in leading investment deals.
  • Flexibility in investment allows collaboration with preferred entrepreneurs and syndicates, fostering long-term relationships.
  • The structure and size of a fund can significantly impact collaboration dynamics and deal flow.
  • A larger fund might necessitate a shift in operational approaches with companies.
  • Semil contemplates the trade-off between raising more money and preserving the "magic" of early-stage investing.

"I think speed wins and convictions. So we will lead deals that we want to lead, and we're just closing one now." "It's better over the long run to pick the entrepreneurs you want to work with and collaborate with those syndicates over time, rather than trying to box out your territory on each one."

These quotes highlight the strategic approach of prioritizing speed and conviction in deal-making and the long-term benefits of choosing the right entrepreneurs and collaborators.

Ownership and Collaboration Dynamics

  • Semil's investment firm aims for 5-10% ownership in startups initially and seeks to maintain that stake over several rounds.
  • The firm avoids owning more than the founders and offers non-threatening advisory support.
  • Semil acknowledges the competitive landscape with other leading firms like Excel and Sequoia, which typically seek higher ownership stakes.
  • The U.S. market is diverse with many seed and Series A funds, allowing for varied investment strategies.
  • Haystack focuses on investing around the larger players who are slower to move, rather than competing directly with them.

"I would say we stop around 5%. So if you look at like what we tell the entrepreneur is, look, we're trying to own five and 10% to start." "Our job isn't to invest. When Excel, Lightspeed, Greylock invest, our job is to invest around."

These quotes clarify the firm's ownership goals and its strategic positioning in the investment ecosystem, differentiating its approach from larger funds.

Fund Deployment Cycle

  • Semil initially considered a three-year deployment cycle for his fund but adjusted to a 24-30 month timeline.
  • He communicates this revised deployment strategy to limited partners (LPs) and acknowledges it as more realistic given the market conditions.
  • The speed of fund deployment is critical in maintaining LP relationships and ensuring a sustainable investment pace.

"No. I knew you and I was thinking about it. So what I kind of concluded over that time and what I told our lps is that for the seed market, I felt the thing we could promise is 24 to 30 month deployments and then doing new funds."

This quote explains the decision to shorten the deployment cycle for the fund, aligning expectations with LPs and adapting to the market.

Investment Mistakes and Learning

  • Semil reflects on investment errors made during the fourth fund, particularly when aiming for higher ownership stakes.
  • He acknowledges a trade-off between quality and ownership and admits to both adverse selection and poor selection decisions.
  • Despite challenges, there are still promising investments in the portfolio that could lead to successful exits.
  • The learning process includes reviewing past decisions and adjusting strategies for future funds.

"I think in fund four, I always worry about the carnage in that fund, and I knew there was going to be turbulence because it was the first time was really going for ownership."

This quote reveals the difficulties faced when shifting investment strategies and the importance of learning from past fund performance.

Venture Capital as a Game of Access and Selection

  • Early-stage investing requires both access to creative people and the ability to select the best opportunities.
  • Generating access and making selection decisions are both challenging and equally important in venture capital.
  • Semil discusses the importance of investing before major players like Excel and Greylock, focusing on different stages and types of founders.

"I think for the early stage? I think it's both. You need access to creative people. You need to select from the ones that come your way."

The quote underlines the dual nature of venture capital, where both access and selection play crucial roles in success.

Advice for Emerging Fund Managers

  • Semil advises new fund managers to build a track record before seeking institutional investors.
  • He suggests using platforms like AngelList to demonstrate investment activity and build credibility.
  • Building relationships with other general partners (GPs) and LPs is essential for vouching and gaining support.
  • Consistent networking and maintaining relationships with LPs, even outside of fundraising periods, can be beneficial.
  • Semil recommends having a clear vision and strategy to inspire confidence in potential investors.

"My advice may not really click with people because they don't want to go through that, but I think one is on Angelus now. There's really no excuse not to have some kind of track record before you go talk to an institution."

This quote advises emerging managers on the importance of establishing a track record and leveraging platforms to showcase their investment activity to LPs.

Learning from Mistakes

  • Semil Shah reflects on two significant learning experiences: a minor warning and a major shift in his own psychology.
  • The minor warning involved a failed meeting with the head of a large university despite a strong introduction and previous successful interactions.
  • The major shift was the realization that not all LPs (Limited Partners) will support a GP (General Partner) after committing, regardless of the GP staying true to their word.
  • Semil Shah had to block two LPs from future funds due to their behavior and demands, highlighting the importance of being selective about partners.
  • The discussion also touches on the idea that some LPs and GPs may not fully understand each other's business models, which can lead to challenges.

"I remember that. Not to out this person, but I would say a major leader of a major successful fund who spent a lot of time with me, who's been on your show, who introduced me, they only have 24 LPs and they're all endowments and foundations, and introduced me personally to the head of this one huge university."

Semil Shah recalls a significant introduction to the head of a large university by a leader of a successful fund, highlighting the importance of networking in the venture capital industry.

"I think there are two. And one was a minor little warning, and one was a major shift in my own psychology."

Semil Shah categorizes his learning experiences into a minor warning and a major psychological shift, emphasizing the impact of both personal and professional growth.

Liquidity Profiles and LP Business Models

  • Semil Shah discusses the liquidity profiles of endowments, foundations, and family offices, noting that they can be idiosyncratic.
  • He predicts that institutional capital will constrict due to conservatism and lack of visibility into portfolios.
  • There is a concern about stranded capital, which refers to money that is either stuck in a company without product-market fit or in a fund that is too large to achieve significant returns.

"Churn is coming because I think one most GPs don't understand how different LP business models work to begin with."

Semil Shah warns that churn (LP turnover) is expected due to a lack of understanding among GPs about the business models of LPs.

"But right now, the liquidity profiles of these endowments, foundations, family offices, et cetera, could be wildly idiosyncratic."

Semil Shah explains that the financial situations of LPs vary greatly, which can affect their investment behavior.

Misalignment of Incentives and Fund Size Escalation

  • The conversation touches on the misalignment of incentives within the LP landscape, where LPs might choose to invest in larger, more established funds for job security reasons, potentially overlooking smaller, high-potential funds.
  • Semil Shah points out that LPs have enabled fund size escalation by going along with it, which he considers a sin in the venture capital ecosystem.

"So I believe in having separate vehicles for separate activities, because that's the best governor."

Semil Shah advocates for separate investment vehicles for different activities to ensure proper allocation and governance.

"I think that's the biggest sin that LPs have committed."

Semil Shah identifies the biggest mistake LPs have made as enabling and allowing fund size escalation without proper governance.

Venture Capital Strategy for Emerging Managers

  • Semil Shah suggests that emerging managers today will find it harder to raise funds due to the changing landscape and LP preferences.
  • He believes that smaller funds will become more in demand as LPs seek to avoid large losses in bigger funds.
  • The discussion also covers the influx of new LPs, such as European corporates and Middle Eastern investors, into the venture capital space.

"So when you go out for your third vintage, assuming your funds are similar size, you're going to be more in demand because these LPs now are now downshifting to the smaller vehicles."

Semil Shah predicts that smaller funds will be more attractive to LPs looking to minimize risk in a contracting market.

"We see it in Europe with a huge amount of European corporates with huge balance sheets wanting to enter venture."

Harry Stebbings discusses the trend of European corporations seeking venture capital investments as a way to innovate beyond their traditional structures.

The Importance of One Deal and the Venture Ecosystem

  • Semil Shah emphasizes that a single successful deal can change the trajectory of a fund, making it difficult to predict which funds will thrive.
  • The conversation also covers the idea that certain venture capital firms have a track record of guiding companies toward significant outcomes, suggesting that the best investors tend to be part of the most successful companies.

"It just takes one deal to completely change the trajectory of some of these funds."

Semil Shah highlights the transformative power of a single successful investment deal for venture capital funds.

"I think that there are a set of funds, maybe 50 to 75, that in partnership with other funds and entrepreneurs know how to guide a company towards a big outcome or a public offering."

Semil Shah suggests that a select group of funds has the expertise to steer companies to major success, indicating the importance of experience and partnerships in the venture capital industry.

LP and GP Dynamics and Strategy

  • The discussion includes the strategies LPs use to allocate their investments, such as geographic or sector focus, and the potential drawbacks of such approaches.
  • Semil Shah and Harry Stebbings debate the effectiveness of LPs' bucketed investment strategies and the value of board members at different stages of a company's growth.

"Most LPs don't live in the Bay Area, or they're not in the market, they're not talking to founders, they're not talking to VCs all the time, and they just have to map it out."

Semil Shah explains why LPs may rely on structured investment strategies due to their geographical and market distance from the core venture capital activities.

"I'd probably recruit somebody who has VC deal experience to help go do directs on top of it and to stay close to the winning graduating companies."

Semil Shah outlines a strategy for managing venture allocations, emphasizing the importance of direct investment experience and staying connected to successful companies.

VC Sins

  • VC firms have increased fund sizes primarily to collect more fees and to manage larger assets under management (AuM).
  • VCs have been lowering the threshold for startup financing, leading to a lack of true checkpoints for entrepreneurs.
  • Capital is being deployed speculatively, resulting in companies with significant cash but no product-market fit.

"I think the biggest one, in addition to fund size escalation for fee grab and AuM, is this lowering the threshold for having each financing be an actual true checkpoint for an entrepreneur."

This quote highlights the issue of VCs prioritizing fund size growth over the success of their investments, leading to ineffective checkpoints for entrepreneurs' progress.

Founder Sins

  • Founders lack discipline in setting milestones and updating investors.
  • Some founders fail to involve their investors in the company's journey, making it difficult to garner support in later stages.
  • Founders' disregard for their investors' contributions may lead to their downfall.

"Here is, I think that a lot of them didn't have their own discipline about creating the checkpoint and milestones for themselves."

This quote emphasizes the importance of founders setting clear goals and maintaining discipline to ensure their startup's progress is measurable and accountable.

Company Updates

  • The majority of companies provide updates to their investors.
  • Establishing a regular cadence for updates is crucial for maintaining investor relations and fostering ongoing dialogue.
  • Failing to send updates can significantly impact the likelihood of receiving future investment commitments.

"I would say the overwhelming majority, but we talk about that in the diligence investment process, and then we actively try to get them on a cadence, like early part of the month, first of the month thing, because then that triggers a conversation for the month."

This quote underscores the practice of setting expectations for regular updates during the due diligence process and the benefits of having a consistent schedule for investor communication.

Respect for Capital

  • Founders and funds must respect the investment made by others and be transparent with their progress.
  • A lack of respect for capital and transparent reporting can hinder a company's or individual's progress in the venture space.
  • The current environment demands not only capital efficiency and growth but also integrity and a partnership mentality with investors.

"If you can't respect the dollars that you've taken, and you can't give those people a transparent, brief view into what you're doing and allow them to guide you in a polite way, then you're probably not set out for the journey."

This quote conveys the necessity for founders to value their investors' contributions and maintain open communication to succeed in the long term.

Venture Landscape Concerns

  • There is a heightened portfolio of risks and a lower money supply in the current market.
  • The venture landscape is expected to undergo a prolonged period of adjustment and challenges.

"The thing that worries me the most is the portfolio of risks that are around us, in addition to the lower money supply."

This quote expresses concern about the increasing risks and reduced liquidity in the venture capital market, indicating potential difficulties ahead for startups and investors.

Portfolio Valuation

  • There is no consensus on how much portfolios should be remarked in the current climate.
  • The process of remarking depends on the stage of investment and the specific portfolio mix.
  • Growth funds may need to compare their investments against public market comparables.

"There is no consensus on this. I think I would just bucket it, which is get seed and early, where you don't really know yet, even if you have a great series b that you've seeded where it is, you do have to pick some methodology and stick with the number and go."

This quote highlights the challenges of determining the appropriate markdowns for venture portfolios in a fluctuating market and the need for a methodical approach.

Investment Outcomes

  • The speaker shares his experience with successful investments, such as Filecoin and Hashicorp, and the significant returns they generated.
  • The discussion also covers missed investment opportunities, such as Opensea, and the lessons learned from those experiences.

"It's been filecoin. Wow. Yeah."

This quote is an example of a successful investment that led to substantial returns, illustrating the potential for high rewards in venture capital.

Investment Advice

  • The best investment advice received is to focus on doing good deals, simplifying the complex nature of the business.

"Paul Martino, DGD, do good deals."

This quote encapsulates a fundamental piece of investment advice, emphasizing the importance of making sound investment decisions in the venture capital industry.

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