For the past five months, the AfterWork team have been pounding the pavement to raise a $30 million VC fund, to invest in pre-seed and seed stage companies in Australia and New Zealand. Last Monday, we announced that we’d called a first close, after exceeding $10 million in commitments. We’ve been floored by the interest we’ve received from people from all walks of life, eager to back the next generation of iconic tech companies.
Here’s a snapshot of our first believers, or investors in our first professional fund:
Venture capital has served as a vehicle for phenomenal wealth creation - both for individual investors, and for the economy - the tech sector represented a $167 billion contribution to the Australian economy in FY211. We are excited to have a diversity of investors in our fund, but would love to see even more people considering an investment in venture capital.
For those less familiar with this asset class, we’ve put together a Q&A that lifts the lid on venture capital.
1. First, what is the venture capital asset class?
In essence, a venture capital fund makes equity investments in high-growth, privately-held, startups. Investors exchange cash upfront for an ownership stake in the business, hoping that the cash injection will fuel the company’s growth, and as such, the business will grow in value faster than the rate at which it’s burning through cash. When the business is acquired or goes public, the VC investor will share in the proceeds. It can be a long time before a company chooses to IPO; and so, the average lifetime of a VC fund is 10 years.
Because early-stage companies fail for myriad reasons, many of which aren’t even within the founders’ control, VC investors build a portfolio of investments, with the expectation that many of their investments will fail. Returns for a VC fund follow a power law distribution - if all goes to plan, a small number of investments will hit their stride and achieve outlier growth, driving the vast majority of returns for the VC investor.
This means VC investors must invest in companies chasing big opportunities, with a product and business model that can scale fast enough to capture significant market share. The ‘winners’ in a VC portfolio have to ‘win’ in a big way, to compensate for losses sustained by rocketships which fail to launch.
2. What makes the venture capital asset class an attractive investment?
VC funds have a unique form of access to the wealth created by the tech sector. Because they invest early on in the journeys of tech companies, VCs capture the value created during startups’ hyper-growth phase.
Take Uber as an example. Uber’s valuation climbed from $5m in its September 2010 Seed round, to $60m at Series A five months later, to $350m at Series B ten months later, to a staggering $69b at its Series G round in December 2015. Uber went public in December 2019 at a valuation of around $75b, or $45 per share. As of August 2021, Uber’s shares trade at below its IPO price, at just $40 per share. This example highlights how the value generated by Uber’s astronomical growth was captured by private investors, including VC funds such as First Round Capital, Benchmark, Google Ventures, Sequoia, and many others. In contrast, investors who only participate in public markets have had little opportunity to share in the wealth that Uber has created.
Closer to home, Australian graphic design startup Canva is tipped to be valued at $30bn USD as of its latest fundraise; a valuation on par with the market capitalisations of ASX listed juggernauts such as Coles, Transurban, and Rio Tinto. Despite its valuation, Canva remains privately held; its loyal backers include a bevy of Australian VC funds, including Blackbird, Square Peg, Airtree, and Skip Capital.
Moreover, historically VC fund performance has been uncorrelated with public equity markets, representing a form of true diversification from listed equities. But additionally, VC invests in disruptors - agile tech companies that are challenging and displacing incumbents, including those which comprise the ASX200 / S&P500. As FinTechs, SaaS companies, digital marketplaces, and direct-to-consumer brands take market share from banks, telcos, retailers, and other ‘traditional’ enterprises, an investment in VC represents a good hedge against investments in the public indexes.
3. What are the non-financial reasons to invest in VC?
In addition to the financial returns, VC investors get to play a humbling role - in choosing which revolutionary startups to back, VC funds play a role in shaping the future. Some funds stand for a distinct vision of the future, such as ReGen Ventures, a fund that invests in regenerative technologies that restore the health of our planet, or Giant Leap Fund, an ‘impact’ fund that invests in rapidly scalable businesses that blend financial returns with measurable social and environmental benefits.
Having a court-side seat to the early days of the next generation of iconic startups is thrilling, as is the opportunity to learn alongside entrepreneurs working at the bleeding edge. As early-stage investors, we feel particularly lucky when we walk alongside startup founders from the very beginning of their journeys, just as they’re building conviction to turn the projects they’ve been working on ‘after work’ into their life’s work.
In addition, investing in VC boosts the local tech sector, putting capital in the hands of the most innovative and persistent founders, to pursue audacious and impactful dreams. In a world plagued by complex, existential problems - it has never been more important to empower original thinkers to realise their visions.
4. What kind of returns can investors expect?
In 2020, venture capital was the highest performing asset class within private equity funds, as the pandemic drove activity and investor appetite in disruptive tech companies. According to a report that looked at 11,000 private funds, venture funds delivered an average annual trailing IRR2 net fees of 54% in 2020. However, 2020 was an anomalous year; most VC funds claim to target an IRR of between 20 - 30%.
It’s worth noting that Australian funds have performed exceptionally well against their global counterparts. Blackbird Ventures’ Fund I, which made investments in Canva, CultureAmp, SafetyCulture, and Zoox, is on track to be one of the best performing funds in the world. In December 2019, Blackbird sold a 40% slice of its first $27m fund for $100m, locking in 3.4x return for the group of 96 investors in its first fund. But as the valuations of these tech unicorns continue to swell, so too do the returns generated by Blackbird Fund I. Square Peg Capital’s Fund Zero boasts similarly impressive performance, with an IRR of 32%, a TVPI3 of 5.2x, and a DPI4 of 2.4x. Fund Zero included investments in Fiverr (which IPO’d on the NYSE) and PropertyGuru (set to go public in a $1.7b SPAC deal).
5. What are the differences between different VC funds?
VC funds can differ in a few ways:
The stage at which they make initial investments: some funds (including AfterWork Ventures) invest at pre-seed / seed, when a business might be pre-revenue, or even pre-product. Early stage investors build conviction by evaluating the strength and complementarity of the founding team, the size of the addressable market, and looking for early signals of customer love and a differentiated product. Other funds specialise in later stage investments, when the business has established product-market fit and cracked a repeatable formula to drive growth. Investing earlier represents greater risk that the company will fail completely, but greater upside if a company achieves outlier success.
Focus on a thematic or business model: some funds specialise in one thematic or business model, and become deep experts in their vertical. For example, Tenacious Ventures is a dedicated agrifood VC fund, run by partners with deep industry expertise and networks within AgTech. Other funds, including AfterWork Ventures, have a more expansive and opportunistic mandate. At AfterWork, we leverage our community of operators, who bring experience and expertise across a range of industries and functions, to accelerate to a robust understanding of a wide variety of verticals.
The number of investments a fund makes: some funds prefer to make a small number of ‘high-conviction’ investments, and target a >10% ownership stake across all its investments. At AfterWork Ventures, our mandate is to build a large portfolio of 80 - 100 portfolio companies, and earn the opportunity to build our ownership in the highest performing of those.
The business model: Until recently, most VC funds didn’t have a distinctive or defensible business model. Andreessen Horowitz was one of the first VC funds to develop a ‘platform’ - infrastructure that helped its portfolio companies to recruit talent, secure key partnerships, and access mentorship from experienced operators. More recently, Tiger Global has made waves by turning around investment decisions incredibly quickly, and coming in at up to 25% above the asking price. As competition in VC investing heats up, strong and diligent execution against a clearly defined, cohesive business strategy will be essential to success. AfterWork’s strategy is community-powered; we’ve coalesced a crew of 60+ seasoned tech operators, who augment every part of the VC value chain: from sourcing deals from their networks, to evaluating specific opportunities, to supporting portfolio companies operationally post-investment. Our community is the source of our edge, and how we earn the opportunity to invest in the most exceptional founders.
6. What makes a good VC fund manager?
Let’s break down everything a VC investor needs to do well:
Generate fantastic dealflow. You can’t invest in opportunities you don’t see! Successful VC funds need dealflow that’s both proprietary and comprehensive. To generate inbound dealflow, VC funds must build a strong and resonant brand, to be front-of-mind for startups raising capital. Funds can also generate deal referrals from their network; the best networks have nodes embedded in all corners of the ecosystem.
When it comes to evaluating investment opportunities, the right mix of skepticism and optimism. When they’re evaluating an investment prospect, VCs need to be incisive, thorough, and visionary - all at the same time! A great fund manager must be diligent when it comes to educating themselves about the relevant sector, but more importantly, must know how to ask questions which draw out unique insights from the founder.
Earn the trust of founders. The most exceptional founders will always have their pick of investors. To invest in the best companies, VCs have to earn the trust and respect of the founding team. In competitive situations where multiple funds want to lead a round, VCs have to show they can add value above and beyond their capital.
Walk alongside founders on the long and rocky road, and help manifest their success. Investment is not an end - it is a beginning. Post-investment, the best VCs work hard to help manifest the success of their portfolio companies, helping them to recruit talent, troubleshoot operational problems, and make difficult decisions. At AfterWork, we’re able to support our investments by making our whole community of operators available to our portfolio companies.
Important to note - a VC fund manager is compensated in two ways: typically, a 2% management fee, and 20% carried interest (or ‘carry’) in the fund. Carry is a share of the fund’s profits; this means VCs don’t get big ‘paydays’ unless the fund performs - thereby aligning their incentives with that of their investors.
7. What’s the rationale for investing in first-time fund managers?
VC firms raise successive funds, each with an investment period of 2 - 5 years. For example, Blackbird is up to its fourth fund, which has $500m in committed capital - nearly 20 times the size of its first fund.
A ‘first time fund manager’ refers to a VC firm that is raising and deploying its first professional fund - like us!
We’re acutely aware that we need to prove ourselves as capable investors by generating a strong track record of returns. We view ourselves as a startup; just like the founders we back, we’re gearing up to build AfterWork over decades. Via our angel investing and previous microfunds, we’ve started to lay the foundation of a powerful investment engine, brand, network, and community. We’ve already made 41 investments (albeit with smaller cheques), and developed a strong discipline around rigorously interrogating investment opportunities, guided by our investment principles.
Perhaps counterintuitively, Preqin data indicates that on average, first time fund managers outperform their more experienced counterparts. We have a few hypotheses as to why - with their reputations and future livelihoods as VC investors on the line, first time fund managers are hungrier, work more zealously, and hold fewer biases about what an investable startup ‘should’ look like, making them more open-minded to truly disruptive companies that more seasoned investors might be wont to put in the ‘too hard’ basket. Additionally, research by Invesco shows that smaller and earlier stage funds have, on average, outperformed larger, later stage funds. It’s harder to put large amounts of money to work at the earliest stages; as such large multiples are harder to achieve when a fund has a lot of funds under management.
AfterWork Ventures is not seeking to replicate the operations of the larger funds in Australia and New Zealand. In doubling down on our differentiated business strategy and community-powered advantage, we have confidence in our ability to screen a large volume of deals, accelerate to a robust understanding of a number of industries and business models, and through adding value post-investment, earn the right to be a long-term capital partner to the highest performing companies in our large portfolio.
8. Does AfterWork have what it takes to build a VC fund for the ages?
AfterWork Ventures didn’t start overnight. We’ve been building our investment engine, sharpening our judgment, and building a track record for four years. We’ve built a community-powered flywheel that is starting to spin: our dealflow is strong, the pace of investment is accelerating, more and more top-tier operators are joining the community, and we’re excited to start investing in companies from our new fund.
We’re still actively raising capital and growing our community of operators. If you’d like to learn more, get in touch!
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[1] Source: Tech Council of Australia
[2] Internal rate of return (IRR).
[3] Total Value to Paid-In (TVPI): The ratio of Total Value to Paid-In Capital which is net of management fees and expenses. This refers to the on-paper valuation of holdings, as a ratio of the original capital invested.
[4] Distributed to Paid-In (DPI): The ratio of Distributions to the total contributions of Limited Partners to date (i.e. Paid-In Capital). This refers to the value of distributions made to investors, as a ratio of the original capital invested.
