No early-stage venture firm wants to leave money on the table. When its fast-growing portfolio companies raise follow-on rounds, and early backers have the right to exercise their pro-rata rights, investors may resort to creating separate opportunity or growth funds. Or they may raise special-purpose vehicles to participate in the successive rounds.
They can also partner with another venture firm to share the pro rata. And that’s where Alpha Partners comes in.
Led by founder and managing partner Steve Brotman and co-founder and managing partner Brian Smiga, the firm teams up with early-stage firms to invest in their pro-rata rights as their portfolio companies grow.
A sampling of its own portfolio shows that Alpha has invested in such companies as Careem, Coupang, Lime, Rover, Vroom and Wish, among other high-flyers. About 80 percent of the companies are in North America, although the South Korean ecommerce company Coupang, which held an IPO in May, is the firm’s biggest win.
All told, the firm, which was established in 2014, had a portfolio of 21 active companies as of May, and has racked up eight exits. Smiga expects four more exits before the end of the year.
Smiga chatted with Venture Capital Journal about the venture market.
Your podcast is called Democratizing Alpha. How do you look at democratization in venture?
In one sense, it’s about the LPs having the ability to get into more high-growth companies. So there’s democratizing for LPs who are underserved.
But it’s also about emerging managers of color and women. Women are 52 percent of the population, but they are way underrepresented in venture.
And we know for companies that grow, that when their leadership and boards reflect the population, they outperform.
How does the notion of democratization work with your investing model?
Here comes Alpha, with the money. We fund the investor’s pro rata and share the carry with them, as if we are one of their LPs. And they continue serving on their boards and together we will benefit. So this is how we democratize for early-stage VCs.
The trend that Alpha has bet on was already emerging before we came along. In that mid-stage growth area, there was $30 billion in investment rights in the last year that didn’t get used. That’s the pond that Alpha is fishing in.
Did you say $30 billion in investment rights?
It’s $20 billion a year if you average it over the last seven years. But in the last year, it was $30 billion.
You can detect this number if you look at the seed and sub-$100 million funds that are on the cap tables of companies as they march toward Series C rounds and then seeing how they all disappear. Some 90 percent of those funds are gone at Series C.
So we’re looking for firms to join us, because this is not going to go away.
We’re seeing a lot of growth of emerging VCs. How does this benefit you?
All the tech companies that have generated so much wealth in the last several years have also created a new generation of VCs. They are ex-operators who have built companies, have created wealth, like at Facebook or Google, or sold their company to Facebook or Google, and we’re seeing so many new VCs from this emerging class.
That spawn of VCs is unending. There’s hundreds of new ones every year. Also, these small specialists fund about 80 percent of the winners, but they are going to have an even harder time raising capital. Under covid, emerging managers have had difficulty as the larger firms captured all of the fresh capital. Most of the new capital raised is going to 10-15 percent of the funds.
What are you looking for in partners?
We’re looking for LPs who already do this on a small scale, or a limited scale, and maybe were late [when it came to] private tech investing. And we’re a way for them to catch up. This could include high-net-worth individuals, family offices, RIAs and small endowments.
On the venture side, we’re looking to talk with any VCs with less than $150 million AUM that could use an opportunity fund buddy. You don’t have to set up an opportunity fund. We’re it.
Regarding opportunity funds, we’re seeing more being raised. Is that trend impacting you?
I think we will continue to see more opportunity funds, yes, because these early-stage VCs will mature and raise a second or third fund, and they will have a larger pool of active companies, and a more consistent track record to bring to LPs. So opportunity funds will grow, but at a slow rate, we think – of say 3-5 percent a year.
Meanwhile, the pool of VCs is enlarging all the time. We have to remember that 50-70 percent of these early-stage funds don’t meet their return hurdles, let alone raise an opportunity fund.
Opportunity funds are great for the source VC, the early-stage VC. Are they good for the LPs? The answer is yes and no. They’re good if they’re from Greycroft and General Catalyst and RRE Ventures. But the jury is out on many of the first-time opportunity or growth funds. The early-stage VC doesn’t have growth investing expertise, so they will have a selection bias with their own companies or the lookalikes.
During the pandemic, prices have risen. Valuations are robust. How is that impacting you?
They’re on our mind. With the public market performance over the last year, it’s inevitable that prices are very high in the private markets. There’s lots of competition for deals, and lots more people putting more capital into the space than ever before, like Coatue and Tiger Global.
We think it’s the perfect time for a growth equity fund because prices will likely not stay at this elevated level. Within the next four years, Alpha will be in a great place because we address the question of how venture firms privately fund the deals. Early-stage VCs will be even more constrained as the larger funds continue to grow in size.