How LPs identify top emerging fund managers with Slipstream’s Alex Edelson | E1898

How LPs identify top emerging fund managers with Slipstream’s Alex Edelson | E1898

Slipstream Investor’s Alex Edelson joins Jason (00:00:00)

  • Venture capital is a long-term game, and the success of a VC firm hinges on the performance of its first few funds.
  • In the early stages, the fund size is smaller, and the core team plays a crucial role in sourcing, picking, and adding value to investments.
  • Over time, teams grow, fund sizes increase, and strategies may evolve, but these changes can have both positive and negative impacts.

Alex explains what a fund of funds is and why people choose to invest in fund of funds rather than invest directly (00:01:28)

  • Slipstream, run by Alex Edelson, is a fund of funds that invests in pre-seed and seed venture capital funds, primarily in the $100 million and smaller range.
  • Slipstream's concentrated portfolio focuses on 9 to 12 core funds, providing limited partners with diversified exposure to early-stage venture capital.
  • Slipstream values founder feedback and uses it to enhance its understanding of successful early-stage venture firms.
  • Slipstream collaborates with emerging fund managers, organizing events and co-investing in their breakout companies, aiding in the professionalization of their operations.
  • Limited partners choose fund of funds for their expertise, diversification, and access to smaller, emerging fund managers that may be harder to invest in directly.

Why early stage funds overperform and ownership in relation to fund size (00:08:34)

  • Small emerging managers are a big part of the best performing funds.
  • Early-stage funds tend to do better on a multiple of cash.
  • High ownership relative to fund size is a great predictor of the return potential of a fund.
  • The math answer is that if you get a winner when you have high ownership relative to your fund size, the returns can be unbelievable.
  • There's also a qualitative factor: first-time fund managers are betting their careers on their success.

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What Alex looks for when picking venture funds, ownership, and why people invest in fund of funds cont. (00:13:09)

  • Emerging fund managers, driven by their hunger and motivation to prove themselves, may lead to outperforming seed funds.
  • Small funds with high ownership relative to their size can generate substantial fund-level returns even with moderate outcomes.
  • Investors should prioritize the minimum level of fund-level performance over solely focusing on the potential for a significant exit.
  • Some investors utilize fund of funds as a means to gain exposure to the venture capital asset class.
  • Top-performing funds are often oversubscribed and challenging to secure an allocation.
  • Slipstream's relatively small fund size facilitates closer relationships with fund managers.
  • Alex Edelson emphasizes building close relationships with fund managers rather than solely focusing on the percentage of a fund he invests in.

Evaluating ability to compete for deals at seed vs pre-seed stage (00:19:49)

  • For seed funds, Alex Edelson expects a plausible path to a 4x to 6x net return after fees, considering historical benchmarks.
  • For pre-seed funds, he aims for a plausible path to a 7x to 10x net return.
  • Edelson believes that a 3x net return in 10 years beats the historical benchmark of the public markets and provides better returns despite the illiquidity.
  • As an individual LP, Edelson typically invests between $25k to $250k in emerging fund managers, with a maximum of $500k for more established managers.
  • He aims for an average investment of $100k in each fund and has a total of a few million invested in venture capital.
  • Edelson sees investing in emerging fund managers as a way to build his network, support other managers, and potentially achieve higher returns.
  • He prefers concentration over diversification because he believes it's harder to outperform with a lower concentration and wants each investment to be a significant part of his portfolio.
  • Edelson acknowledges that some investments will underperform while others outperform, so he carefully considers returns and the difficulty of generating DPI.
  • He believes that a net DPI of 3x or more should satisfy any LP in a venture fund.

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Picking winners: Identifying promising companies early and tracking them (00:25:08)

  • Slipstream monitors the portfolios of approximately 10 funds, each holding an average of 30 companies, totaling around 400-600 tracked companies.
  • Slipstream identifies winning companies based on high user adoption, positive user feedback, and interest from top-tier firms seeking investment opportunities.
  • Revenue growth, quality of revenue, and high-margin business operations are crucial factors in determining a company's breakout potential and distributable profit.
  • Slipstream co-invests in companies that have already received funding from reputable investors, allowing for up to 20% of the capital to be used for co-investments.
  • Slipstream's current fund structure allocates half of the fund to primary investments and the other half to follow-on investments, with criteria to identify "likely winners" and "definitive winners" for follow-on investments.
  • Slipstream encourages investors to track their level of conviction and the performance trends of companies over time to make informed decisions.
  • Slipstream uses a "mini deal memo" to facilitate internal discussions and decision-making processes for potential investments, promoting thoughtful debate and improved decision-making.
  • Slipstream considers each funding round as a potential "buy" or "sell" opportunity for companies in their portfolio, evaluating whether to buy or sell even if immediate action is not possible.

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Generating liquidity for LPs and picking emerging fund managers (00:40:08)

  • Alex Edelson, from Slipstream, emphasizes the importance of portfolio construction, liquidity management, and actively thinking about exit strategies when selecting emerging fund managers.
  • LPs should focus on fund managers with portfolio construction that can generate fund-level returns, meaning high enough ownership relative to fund size to benefit from both modest and big winners.
  • When investing in small funds, getting 2-3% ownership is excellent, while 1% ownership is solid.
  • Accelerators provide great ownership with small checks due to low entry valuations, but they require a lot of work and a high acceptance rate.
  • A sustainable competitive advantage in the team, such as deep domain expertise, operating experience, or a unique sourcing strategy, is crucial for building a flywheel in a Founder Community.
  • Founders should love the Venture fund and want to work with them, leading to proprietary deal flow.
  • The strategy should be tailored to the Venture fund's unique strengths and competitive advantage.
  • The best investors at the next stage should trust the Venture fund, track their deals, and invest in them.
  • The Venture fund should have scrappy, entrepreneurial, and hungry team members, regardless of their experience or fund size.

Competing for deals at the seed stage, the differentiation between pre-seed and seed, and deciding when to double-down (00:56:47)

  • Pre-seed entry valuations are typically below $1-2 million, while seed-stage entry valuations range from $15-30 million.
  • Pre-seed companies are very early in their evolution, while seed-stage companies may have revenue and be further along.
  • There is less competition at the pre-seed stage, but the same companies may receive offers from both pre-seed and seed-stage funds.
  • Key criteria for investment decisions include sourcing, picking winners, and doubling down on successful investments.
  • Slipstream identifies top emerging fund managers by focusing on product velocity, consumer love, and early adopters.
  • They look for companies with a 2x to 3x growth rate.

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