7 Questions LPs Should Ask VCs (But Don’t)

Opinion

It’s that time of year: annual investor meetings for limited partners (LPs). LPs are the people who fund venture firms and the general partners (GPs) are the people who lead them. At these meetings, LPs pour over general partners’ (GPs’) reports, calculate TVPI (total value: paid in)/ IRR (internal rate of return), digest confidential past results, test the waters on new funds, jockey themselves into better funds, and mentor their investor base as to what is new and emerging.

I am getting invited as a VC into these pretty special LP meetings for my work in doing entrepreneur lead generation. Perhaps some LPs see my work with pre-entrepreneurs as innovative. There have been zero other VCs in attendance at the LP meetings I have gone to. Basically, I am special because LPs liked my ideas, liked my silly fund name and liked my investment theory based on a conference they met me at: Venture Alpha. My invites all came from doing well at that one conference where I crashed one CS major in (Cory Levy, CEO of ONE) and hugged one CS major who was the Venture Alpha keynote (Aaron Levie, CEO of Box.net). In the same way you do credit card application lead generation for a 19-year-old junior who eventually takes out a loan to buy a car at age 26, you also lead-gen 26-year-old CS major CEOs by finding them when they are 19. That’s the pattern that LPs recognize that I am attempting to replicate.

But I am only in my third week of being a VC, so it is still very weird to be a fly on the wall at LP investor meetings. The meetings are extremely exclusive. And comprehensive. LPs drill down into the details of their specific VC funds—it’s all information the public almost never sees. While I listened, it hit me that the VC model is not broken. Silicon Valley is cyclical. LPs know VCs need to find a whopper of an IPO within every fund to meet TVPI goals and IRR goals (internal rate of return). But getting there is a numbers game. How many entrepreneurs, founders, CS majors, developers, pre-entrepreneurs are in your VC firm’s lead-gen funnel? Saying “deal flow is everything” does not put a concrete, executable plan into motion. I argue it paralyzes.

That led me to think up a few questions that LPs at these meetings should be asking their GPs—but don’t seem to.

1. What does playing Moneyball mean to your firm?

There is one right answer.

Your firm had better be building a massive farm system of IPO potential. We all might have zero clue about which firms will eventually go public, but the key is to have a specific, distinct, transparent, tactical, granular, measurable farm program in place. That takes massive work. Executing Moneyball is about generating a large pool of talent, and making that large pool of talent more talented.

VCs have gone on record at public events talking about Moneyball. They have cited the OBP stat. The “on-base-percentage” statistic does not have an equivalent in VC investing. (It is also inherently obvious that none of those VCs who poo-pooed the Moneyball concept ever read the book or saw the movie.)

VCs who actually have read the book include Roelof Botha. He even recommended the book in public at MJAA conference in 2006 , around the time he invested in YouTube. In short, the data analysis part of the Moneyball concept is not the nugget of knowledge…It is the work that scouts now must do to develop massive and specific entrepreneur farm systems.

From the movie: “Every at bat is like a hand of blackjack played in a casino where your odds massively change based on each pitch dealt.” That has applications for farm team member mentorship and development. I want my fund to have entrepreneurs batting during 3-ball, no strike counts. Getting to a 3-0 count is more likely when you execute 2 to 7 guacamole recipes for entrepreneurship.

2. What matters more in how you recruit and develop venture staff: entrepreneurial experience or operations experience?

The answer I’d be looking for is entrepreneurial experience. You don’t have to have a team made entirely of former founders, like Founders Fund or True Ventures. But what experience do your GPs have as entrepreneurs, besides roping your one LP that launched Fund Uno?

3. How are you using board seats to generate leads and wedge your fund into the best deals?

The old way was to match an emerging hot portfolio company with sexy brand name partner at your firm. The partner or principal who sourced the deal might get bumped off the deal docket, but the marquee partner and team member got a nice feather in the form of sexy new startup and an uptick in personal brand.

There is a new innovation in board participation.

Using board of director and board of advisor seats to do lead gen essentially increases the probability of buying stock at the best companies. This maneuver adds you to the waitlist to buy stock in future fundraising rounds. It also allows a long look into the company. As GP, you and your partners should informally head up subcommittees with a specific purpose that builds shareholder value.

If the last formal training your GPs got was a half-day seminar at Kauffman’s Center for Venture Education back when they were associates…maybe you should spend some of that management fee and train your staff in Board of Director 2.0 stuff.

4. How are you planning to get your own presentation day at Y Combinator?

Sequoia gets their own presentation day at YC.

Kleiner Perkins gets their own presentation day at YC.

A presentation day allows for your firm to get a nice long look way before the 80 other venture firms. If the YC startup you love loves you back, you can have them pulled from Demo Day and just fund them without a bidding war. Buy some deal flow insurance and send all available partners to Demo Day anyway.

5. How are you formalizing sidecar, portfolio founder funds?

No one really knows what a sidecar fund is.

Sidecar funds are little funds with complex structures and more complex tax implications. Funds have founders bird-dogging new startups. By bird-dogging I mean lead generating new founders. Sidecar funds are meant to share the upside of the VC investment with the founder that brought in the new deal.

First Round Capital has a risk pool where your startup owns a little stock in the rest of the portfolio companies. Formalizing sidecar funds might be worth examining, clarifying and formalizing. Sidecar funds do not have to have exactly the same fee structure as the parent fund. Sidecar funds can differ from the 2/20 structure in that it can be 0/20. (2/20 means 2 percent management fee and 20 percent carry. Management fee is percentage of total fund. Carry is percentage of the gain that is kept by the VC.)

I like the concept of paying founders to do lead gen using a 0/0 side-car fund. The founder brings you deals and they do not get paid. Their reward is attendance at an industry conference which doubles as a mini vacation but is a clear business expense.

6. Do you ever eat at dorm cafeterias?

Jesus mentored his 12 co-board members by eating with them. A lot.

Eating at Stern Cafeteria on Stanford’s campus is demeaning, so let’s at least see if you as the GP can have partners willing to crash the dorm at 5:00 pm and eat with undergrads. This is the Fortune 100 executive equivalent to eating lunch with the third shift. The third shift eats at 3:00 am, since they work from 11:00 pm – 7:00 am.

The Silicon Valley equivalent to third shift lunch is eating a fourth meal with CS majors at approximately 12:30 am. Plot spoiler: when you show up, you’re treating. The difficulty is getting the kids to come out from under the rock where they are coding.

Have you trolled computer science majors at Stanford? How would you?

Sure it’s a hits-driven business, but what drives the hits are CS kids.

How do you charm a CS kid? Where do you take these CS kids on field trips? You need a strategy to find the next Larry and Sergey. Remember, according to Silicon Valley lore and urban legend, KPCB found Sun on the second floor of the Stanford CS lab, but lost Cisco to Sequoia because KPCB didn’t check the basement.

7. How are you adapting to a world where some investors are offering $800K convertible note rounds with no board seat and no cap?

There is a problem when you are taking equity-level risk with near commercial debt lending-level returns. Getting all the downside risk with a small sliver of the upside is not going to help anyone’s TVPI. (TVPI distributed and undistributed portfolio value to original invested capital.)

Me, I am doing guaranteed exits while they’re in school and looking to fund pre-seed pre-preneurs.

By “guaranteed exits” I mean having 2 to 5 CS majors executing 20 to 45 steps. Their startup isn’t concocted from scratch. It is a sequel business meaning it is 80 percent stuff that exists already and 20 percent new. The industry problem is sourced from some industry expert veteran. It is “guaranteed” in that it works about 60 percent of the time. It is done under the umbrella of a course called “Unofficial ENGR 145” at Palo Alto Community College (aka Stanford).

Upon “sale” of company in the $20K-50K range, the CS majors commit the next two summers.

When I say “fund pre-seed, pre-entrepreneurs,” I mean you should pay to get student pre-entrepreneurs into tech conferences like Web 2.0, TechCrunch, Launch, DEMO, SXSW, Summit at Stanford, and CES. The management fee itself can and should be invested. It is the execution of paying founders to do lead gen from above point No. 5.

By asking some of these tough questions, LPs can stimulate VCs to innovate and perhaps get better returns.

Larry Chiang is CEO of Duck9 and teaches Engineering 145 as a Stanford Entrepreneur in Residence. He has a fund called "Larry Chiang Stanford G51 Fund of Stanford Founders." Follow @

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12 responses to “7 Questions LPs Should Ask VCs (But Don’t)”

  1. Peter Mullen says:

    Dude, why are you giving up all your secrets for success in a public forum? This is great stuff. I’ve long advocated the event circuit (and I guess now you can add the cafeteria circuit) as the absolute best means, not just for lead gen (I’m in sales/bus dev) but to initiate and foster long term trusted relationships with entrepreneurs and those who love them. Not many people get this. Thanks for the post.