Next in The Seed Series we talk with Beezer Clarkson Managing Director on the Sapphire Partners team, an investor in early stage venture funds globally. This interview is a departure for The Seed Series as we typically interview early stage investors General Partners (GPs), and not Limited Partners (LPs) the investors in venture funds.
Sapphire was first structured to invest directly in growth stage companies. More recently the firm added Sapphire Sport. We talk about Sapphire Partners approach to investing in funds, how there is no ‘fast’ in venture, and about #OpenLP. Scott Brown, VP of Marketing, joined the conversation. The following has been edited for brevity and clarity.
Gené: How did Sapphire move from investing in growth stage companies to investing in venture funds around 2011?
Beezer: The direct side existed first. There was a team of direct investors and when they were thinking about accessing the early stage, predominantly Series A, they decided what would be interesting, would be to be an LP in funds because then you touch many more early stage portfolio companies. We have three different investing groups on the platform. Each team is a separate team to a separate pool of capital, and sometimes a different LP base.
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Gené: The three groups are Sapphire Ventures, Sapphire Partners and now Sapphire Sports. How is Sapphire Partners set up to invest in early stage funds?
Beezer: We specifically constructed our vehicle with the thinking of what do the General Partners (GPs) want. GPs want permanent capital. So we went with an evergreen structure which is different from how Sapphire Sport and Sapphire Growth has done their fund.
If our goal is to invest in the best early stage venture funds, they will be the best because they invest in great companies. And great companies by default should be of interest to our growth fund. That’s why it’s virtually organic, but we don’t believe in creating rules around that.
You need to have more than capital to bring to the table. And that is true for the direct side and the indirect side. We think your LP should be a strategic asset. I don’t mean that in a corporate strategic way. Maybe what you need right now is just money. Maybe you need advice. Maybe you need introductions. These are folks who are on your side. What more can you do together. Having that conversation feels very logical.
Gené: How do you assess a potential fund investment?
Beezer: We try to understand — why you? Why are you doing this fund? Why are you going after whatever opportunity set you are after? Why do you think you’ll be competitive, your geographic focus, your expertise — it could be all sorts of things. Understanding your General Partner CEO company fit is really important.
We have not invested in people who have never invested before. We have invested in people who have spun out. We’ve invested in very strong non-institutional angels. We look to underwrite Series A funds with 3x net. And a seed fund 5x net. We have to believe that’s possible. We will look at when you’ve made investments, how many of them have become a 5x or 10x return, and how many of those need to be true. And who’s in the team? How big is the team, and what are the team dynamics?
Gené: What is a 3x net return?
Beezer: A 3x net return means that the fund has returned 3x the capital they raised net of fees and other costs. So from an LP perspective, that means if an LP invested $10m -they received back a full $30m.
Gené: What is a good return and how do funds achieve that?
Beezer: How do you make a 5x seed fund? What needs to be true? And it’s different if you’re a $250 million NFX seed fund versus a $25 million seed fund. There is no formula. Around the $40 million dollar fund size your ownership starts to matter. Most people say they start being conscious of the impact of ownership of their checks around the $40 million fund size. Smaller than than you can write a range of check sizes. It’s easier to get in for $250K or $50K, and your ownership can be smaller, and still be impactful.
Nothing guarantees you returns. We have yet to find a fund that has had a significant return, call it 5x, that has not had either a decacorn type exit or multiple billion dollar exits. If you’re a $50 or a $75 million size fund, you still need to have multiple billion dollar exits.
Gené: You mentioned it is a busy time in seed.
Beezer: From an entrepreneur’s perspective, I’m sure it can be great news, as it represents more opportunities to find someone who will fund their companies. Which can also benefit the follow-on investors (say those focused at the Series A and on), as the more amazing companies that get started, the better. The downside is of course the fears of overcrowding and increased competition, which can drive valuations up, and then potentially drive returns down.
Gené: Given that even seed funds need decacorn or multiple billion dollar exits, are most seed funds too risky as a funding bet?
Beezer: It is certainly a question that LPs consider. And some LPs just don’t do seed funds, or not first time ones, or ones under a certain size. Other investors look at the institutionalization of seed and see it as an opportunity. I would suspect though that most seed funds, especially the smaller ones, do not have predominantly institutional LPs. Most small funds start out raising from friends and family, HNWs, entrepreneurs they have backed or family offices. As they raise subsequent funds over time seed funds then tend to institutionalize.
Gené: How much do you invest annually in early stage funds?
Beezer: Right now we’re between $100 and $125 million per year. We work in the US, Europe and Israel — predominantly US, predominantly Bay Area, some New York, a little Boston, LA and then Europe, and then the smallest categories in Israel.
Gené: How much do you like to invest in each fund?
Beezer: For a series A fund that’s a couple hundred million to four or five you are looking at checks that are $10 to $15 million. Our goal is to write a check, that is meaningful to the GP, but also friendly and collaborative. We have written smaller checks for smaller funds.
Gené: Are those funds committed to existing firms that you’ve invested with in the past?
Beezer: There’s not been a year we have not invested in somebody who’s net new to us, whether or not they’re also net new to the world. We believe that’s a very healthy part of our product that we want to keep going.
Gené: Do you reassess your commitment to non-performing funds?
Beezer: You anticipate being in a fund for decades. You make the investment because you believe this will be a five to six to seven fund run, and maybe longer. Some rejuvenation on the platform, is where funds have had strong performance, but it’s been something with the team. For whatever reason they decided to do different things. Maybe someone wants to go later stage, someone wants to go earlier. That creates room for new managers. Once you commit, typically LPs stay part of it, because the fund is working. Why would you want to step out? Getting back in is not gonna be easy.
Gené: Are there funds you invested in that you can disclose?
Gené: Do you look for new fund areas where you do not have exposure?
Beezer: We’ve joined a fund this year that I can’t name. They’ve been pushing into the frontier edges. It’s about noticing someone who has a thesis around a space that we find interesting. We do want to make sure our portfolio is well-rounded. We have a large love for enterprise, and a large love for consumer and we want to have both in our portfolio. We have DNA on the platform that we can pull on the enterprise side. If you look at the returns in the market, you absolutely have to have consumer. So we’ve been careful to make sure that is represented. We don’t want to be too narrow.
Gené: What is the timeframe for returns?
Beezer: The bulk of the returns will start coming back to an LP at somewhere between years eight and ten to be conservative. We can push it out a year or two. You do see acquisitions that can happen sooner, and this also depends on your fund size. If you’re in a smaller fund, you can have exits that happened earlier because a company was acquired, and it’s meaningful.
You don’t have to wait for year fifteen for every company. For most funds the actual number is a fourteen or fifteen year life. And then there’s a way of managing out the tail. Usually, the tail is not where you expect the big productivity to come from.
The feeling of fast in venture is actually the growth of the companies, and not the management of the funds.
Gené: And finally, why did you start #OpenLP?
Beezer: We launched in 2016. You go online, and there are all these direct investors, all these entrepreneurs, and why aren’t the LPs talking? Some folks were active like Chris Douvos, Top Tier, Weathergage, and Cendana. The goal was to be supportive of the industry. Encouraging getting more LPs to communicate, and collaborate and amplify the message.
When we were mulling the idea of #OpenLP, Notation Capital launched their podcast Origins. They said, we think there’s an interest in the voice of the money behind the money. We want to do a podcast just about LPs. Would you come on, and would you help us invite guests? It’s like the serendipity of an idea.
Scott: It’s interesting to see what topics people are actually looking at. It ranges from market trends; sector and geography. Then you get a lot of people looking at the basics like– How do I run an annual meeting? What’s a good best practices for data rooms set up? It’s almost like people don’t want to feel alone in the wilderness and they’re looking for context and best practices from others. There’s definitely a community of sharing around them.
Gené: Thank you Beezer and Scott.
Illustration: Li-Anne Dias.