Cup of Zhou

Two weeks ago, Ted Seides put out a great blogpost titled: The Investment Office Playbook – What Managers Don’t See. It’s the truth behind the veil of “It’s not you, it’s me” answer that LPs give. And that the best time for managers to be approaching CIOs at institutions happens to be:

1. 1-2 years after they’re just sworn in (in other words, after they’ve figured out their strategy)
2. Up to 2-4 years after that period when they’re deploying against that strategy
3. And around years 11-13 where they’re now restructuring their portfolio after their previous portfolio has been optimized and reached maturity

Last week, Sequoia’s Jess Lee shared a fascinating product-market fit framework. Probably the best breakdown of solutions to problems mapping I’ve seen of late. It echoes much of what I’ve written before, but more eloquently put.

And the reason I bring this up is not to induce whiplash as you’re reading this blogpost. But that it relates back to when to raise from large LPs. As most of us know, there’s a strong correlation between fundraising as a founder and fundraising as a GP.

The first step is to have a product that large LPs can invest in. As a matter of fact, you need to have a specific product (aka fund strategy) for the LP you wish to court. For example, if a large LP’s minimum check size is $20M and their maximum ownership is 10%, and you’re a $50M fund, you don’t have what they’re looking for. That’s okay. You should never resize your fund purely on an LP’s check size and ownership.

The second is to understand their deployment timeline. In the case of large LPs, like endowments and pensions, that’s usually 2-4 years after a new CIO is sworn in. And years 11-13 when they’re rebalancing their portfolio. For other institutions, like some corporates, it’s actually in the bylaws that every three years, there’s a new Head of Investments. Hell, at Norges Bank Investment Management (NBIM) — the largest sovereign wealth fund, or at least one of the largest ones — a new CEO is sworn in every five years. So the clock is always ticking.

To the second point, for a large LP:

Years 1-2

When the new CIO is just sworn in, in many ways, that might be the best time to pitch a new paradigm. When the strategy has yet to fully shape up. Will you get many checks during that period? Likely not. Unless you’re a pre-existing trusted relationship of the CIO. But even if you do convince the CIO/team, they’re likely only allocating a very small percentage to that field, which for the most part, should work for you.

The goal of the value proposition, and subsequently the onboarding and tutorial, is to give people the activation energy needed to overcome the customer mindset. As such, it means one’s product can’t just be 10-20% better, but 10X better.

For instance, to get over the “yeah, right” and the “it is what it is” mindset, in the words of NFX’s Omri Drory, “the best way to manipulate energy, and get what you want, is to remove that ‘imagination barrier.'”

As such, the CIO must believe in the new paradigm. In all fairness, this takes more validation and big headlines for a tenured CIO to usually begin to believe these.

Years 2-4 (and 11-13)

They’re deploying against a top-down approach. And just as in years 11-13, they’re looking for the best in class solutions for each vertical. Meaning they’ll talk to hundreds of managers and look through thousands of pitches to pick just a few. Processes are long because they dig deep on these multi-fund relationships, but this is also an opportunity for them to increase the surface area for luck to stick.

While we all know past performance isn’t an indicator of future results, there is a reliance on metrics and the consistency of such metrics. For instance, if one were to take the top 2 investments in your portfolio and bottom 2 investments and throw them out, what does your remaining track record look like?

Or if some of your funds have yet to have meaningful distributions, graduation rates become rather important. Not just that on average, 30% of seed stage deals graduate to Series A. And 30% of Series A to B. But how many of your deals graduate past more than one subsequent round? For example, do more than 10% of your seed deals graduate to Series B? Although, to play my own devil’s advocate, vintages post-2019 have yet to really learn the true impact of loss ratios.

In closing

The truth is it’s hard to tell when the best time is. And oftentimes, it’s just a matter of luck. For one to have the right fund a specific LP is looking for at a time when liquidity is good.

But in many other ways, like Ted suggests in his blogpost, it’s the ability to think from the perspective of an LP that is invaluable and greatly appreciated as an LP.

Photo by Who’s Denilo ? on Unsplash

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The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.