Six years ago this week Satya and I took our Homebrew deck on the road (as far south as the Rosewood!) and began raising Fund I. Despite now being on our third fund, we still approach our work with a beginner’s mind, working hard to get better at what we do every day. But there are some things we’ve learned and frequently new/aspiring managers hit us up for advice.

Each firm is its own special animal, adopting some industry best practices when there’s no reason to reinvent, but also trying a handful of new approaches that make them who they are. This is certainly the case with Homebrew. That said, there are two portfolio modeling/management tips that I do think are valuable exercises for every Fund I. And since I find myself repeating them frequently on advice calls or coffees, let’s jot them down here so I can send a URL over instead of a meeting invite 🙂 Note: The two points below are most applicable for, say, funds under $25m where you’re trying to prove yourself in order to raise a larger, institutional second fund.

This cat has nothing to do with this post. I just didn’t want to use a stock photo of a laptop.

If Your Portfolio Model Assumes Outperformance Across Multiple Metrics, I Don’t Believe It: Every VC fundraise has an Excel sheet that forecasts the performance of the fund. It’s pretty basic but is meant to give managers (and their potential LPs) a sense of how many companies will be in the fund, ownership targets, dilution assumptions, reserves strategy, exit expectations and ultimately, a target return for the fund. This exercise is also known as “let me show you how we get to 3-5x net.”

Often I see the forecast models constructed with a bunch of assumptions that are totally out of whack with historical norms and current trends – often dramatically underestimated dilution pre-exit, zero failure rate in the investments or outcome modeling suggesting every one in 10 backed startups will be a $1b+ exit. Sometimes new VCs think this conveys confidence and high standards for themselves but in reality it shows sophisticated LPs that you don’t really understand venture. Or at the very least, you have a model requiring a high degree of difficulty to succeed. It’s better to show a reasonable way to get to expected returns and then if there’s upside surprises from there, fantastic. I think you can get away with forecasting *one* factor being better than average, so long as that is backed up by a hypothesis as to why you can achieve it relative to your peer managers.

For Fund I, It Is Better To Get Into Great Companies With Less Ownership Than You’d Want (Or Without Reserves To Protect Pro Rata) Than It Is To Be In Mediocre Companies: Unless your strategy is to show you can lead rounds, in which case you should really have a larger fund anyway, I’m going to advocate something perhaps controversial here: focus more on company quality than ownership targets. Better to have a range – say 2-5% (and get as much as you can in each deal you do), than have a min (5%) and walk away from deals where you can’t get that much.

Why do I say this, especially since our own fund strategy is fewer investment with concentrated ownership? Because I think it’s easier to make the case to future LPs that a larger fund means you’d be able to get, for example, 4-8% of ownership in these great companies you backed in Fund 1, and/or protect ownership in your winners, than it is to convince LPs that a larger second fund is going to make you a better picker.

The one caveat here – it’s hard to jump more than one weight class per fund. What I mean is, if you were writing $50k checks in Fund I and then tell LPs you intend to write $1m checks in Fund II, they’re going to be skeptical that you will get the same access. Your competitive set changes, your operational support expectations change, your follow-on strategy changes, etc. Too much. But if you show adeptness at writing $50-$100k checks and do right by those founders, an LP will believe that, with more dry powder, you can write $250k checks into those companies initially and then use another $500k to protect your ownership in the best ones. That’s how you ladder from a $20m fund to a $50m fund responsibly IMO.

Anyways, your mileage may vary, and we’re still very much in a “prove it out” ourselves phase, but I believe these two things to be true and hope they help you out!