It’s nearly impossible to mix local geographic interests with venture-scale returns. That’s why the big brand name venture firms from Silicon Valley or NYC are unlikely to setup shop — or even visit — your small town.
The first step is to understand how investors make decisions. The second step is to realize that VCs aren’t incentivized to visit your town. Let’s take a quick look at how they get paid and then I’ll explain exactly why they’re not planning to visit you.
VCs are paid on management fees and carry — you’ll hear something called “the 2 and 20” to describe this. The first number is the management fee and the second is the carry.
Let’s pretend, for example’s sake, that I was the sole investing partner of a fund managing $10M. On a typical “2 and 20” model, I’m taking home 2% of the fund every year just to manage the fund and I get to keep 20% of any profits after I return the original $10M principal back to my LPs.
Let that sink in for just a minute.
When you’re getting paid on the standard 2% and 20% model, the overall incentive for a professional VC is to raise larger and larger funds. When they raise larger funds, the number of investable companies becomes smaller and smaller.
Still with me?
Here’s the bottom line: VCs paid on the typical model are incentivized to raise bigger and bigger funds. The problem, however, is that the average startup that survives long enough to build anything meaningful is more likely to get acquired for $20M-$100M instead of going public.
NEWS FLASH: Big VC firms don’t have to travel. Anyone building anything big is going to go visit them. Stop wasting your time, money and efforts trying to win those big funds over.
Here’s what you should do instead:
- If you really want to bring VCs to town, aim for funds managing less than $75M.
- Teach your founders to talk and act more like their coastal peers.
- Recognize that there are great companies that will never fit the venture returns model and that’s OK. It’s better to have 10 companies making $1M/year consistently than it is to have one company hoping to make $100M/year.
As an aside, I believe there’s room for a new venture firm to completely dominate the early stage tech startup scene across the Midwest. Here’s the sneak gist: raise a $10M fund, invest $100K into 30 companies, reserve the rest to follow on in the best of them and repeat this every six months.