At a business lunch the other day a banker said he was glad to see that LEV was into “meat and potatoes investing.” I smiled as this is not only a Midwest thing to say, but it’s also a fair assessment of our appetite for basic ingredients. (I had a chicken bacon wrap for lunch… with fries.)
What did he mean? What was the context? What changed since my last meeting with him?
LEV launched with a broad thesis related to active small business investing. We intended to invest in almost anything with a) positive cashflow, or a plan that our money or time would get it there quickly and, b) was not real estate, drug development, or otherwise couldn’t make 20% IRR on <50% debt to assets with reasonable assumptions based on recent internal company data that we understood. Early stage technology companies were allowable. And by “allowable,” I mean, we wanted to put up to 15% of the assets under management (AUM) into this space. Again, we planned to be active, as in a “let’s get our hands dirty” sort of helpful way. Mikel and I have experience in B2B SaaS and figured we would grind it out alongside the founders of a few young companies and save them from making the same mistakes we had made earlier in our own businesses.
At six months in, and after looking at hundreds of startups, and investing in just a few, we began wondering if our time investment in this sub-strategy would be meaningful to our partners. With very low single digit AUM percentages actually deployed, and more capital coming in, we also needed to “hit it big” in order to move the needle on the whole. The original belief was that if just one of these was a 100x return it could contribute double digits to a cumulative, annualized compound return to a relatively small fund. We pushed harder over the next six months and narrowed around AgTech and FinTech, looking at several hundred more and investing in just one.
Now we began really wondering what was going on. Why don’t founders want to take our experienced money and grow safer? They can control more of their business… Sure, it’s a lower valuation, but we’re good partners! Don’t they know they are most likely to either get crammed down, fired or go bust? The final conclusion: No. They do not. At least not on any meaningful scale. They think it won’t happen to them. I get it. I’m an entrepreneur, too. I’ve just got a few scars to remind me of how quickly things can go sideways. If they don’t want us in the trenches with them, we are moving on.
Anyways, our 100x return on a startup may yet happen but the work and risk as LEV grows do not seem commensurate with the rate at which we are able to have impact in other areas. This is especially true as our edge fades. We began by writing small checks in the earliest stages (first and only professional money in) where we could bring an edge with us. This made deal terms favorable and encouraged alignment around goals of how not to raise money later. I still believe that a huge amount of value is generated from simply going from 0 to 1. No time in the history of mankind has it been easier to create a business and effect so many people so quickly. I hope many more start.
However, if we stink at convincing founders that this is a respectable and safer way to extract value then we should stop. I believe too many of our prospective founders prefer the limelight over the bank account. However, if they are willing to speculate on the hype cycle to get rich then who am I to judge? LEV simply has no edge when it comes to maximizing exit valuations to strategic buyers, and we certainly are opposed to infinite capital raises regardless of per share value. I have no close friends in CA or NY that will write big checks without thinking deeply.
Further complicating our allocation decisions, we launched with a plan to concentrate our top holdings. I am comfortable piling on when the risks are low and the impact is meaningful. I will make mistakes however and we provide a terrific service to our partners by juggling a few key holdings in diverse areas to limit the impact this whiffs might have. For me, the diminishing return to diversification means our top five holdings make up 50-80% of our AUM. Basically, I am not only okay with a few investments, I think it is critical in order to do exceptionally well. Actively retiring the risk is critical to this concentrated practice. To accomplish this in super risky startup land, I might as well own it all myself (no offense.)
So, as LEV grows, I believe we are transfiguring to a higher form. There is no value in staying exactly as we were at launch. There is nothing wrong with the way we launched. We are practicing what we preach. We observe the reality of the market and realistically orient ourselves within that market. We make decisions and act them out each day. Rinse and repeat. It’s not a change of strategy or a massive pivot, as much as a repositioning of our time spent looking at startups.
If you are awesome and understand this blog post, contact us. However, we won’t be strategically attending many pitch events and will not be the coolest VC in the Midwest. Instead, we will remain passionate about delivering practical, grass roots, risk accounted growth… one step at a time.