📶 how some VCs are winning higher ownership positions

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Good morning 👋

Clay here. I’m underwater with work, so this week’s piece is a little shorter.

That said, let’s get right into it.

Let me know in the comments what you think about the shortened version of this newsletter. If you like it, we can keep it.

This Week in Venture

VCs are starting more companies

The standard VC model is old news.

The new model?

Getting your hands dirty at the ground level by incubating companies.

Why it matters: Early-stage investments (even at the pre-seed and seed) have become more expensive. VCs can either pay up for more ownership, or they can take a different approach to earning more equity, and more funds are starting to opt for the latter.

Incubating companies sounds good in theory, but it is worth calling out some of the reasons this hasn’t become a standard practice. There are always hidden costs that go into making this practice a reality, and here are a few of them:

• It puts management fees to the test. Running a fund off of 2% management fees is already difficult for smaller funds. This becomes even more difficult when you need to allocate a percentage of dollars to help businesses get off the ground.

• It mis-aligns incentives with operators. The old startup studio model got a bad rap because of how much equity the studio would take in exchange for getting things up and running. 30%+ was common, and we’ve heard of instances where that number is as high as 60%. Taking this much equity upfront makes it hard impossible to align with the takeover team, and it also makes it difficult to find quality operators to take over.

• You need LP alignment. Running a startup studio means that you have to leverage every inch of your network. You’re helping with customer discovery, market research, and other nitty gritty details. If your LP base isn’t comfortable with you spending more of your time in the trenches vs. looking for more deals, it will cause friction.

• You’re limited to certain geographies to start. There’s a reason that NYC has more startup studios than any other region in the US. You need to have close proximity to talent, capital, and other resources. Not saying it’s impossible to have all that in smaller cities, but it’s a lot easier in innovation hubs.

What happens next: Ownership and price sensitivity are back, and we don’t see that changing any time soon.

We think it’s easy to do startup studios the wrong way, so if you’re thinking about launching an incubation hub for your fund, you should take a step back and learn from those that have been able to pull it off the right way. Primary and Up Partners are some examples of funds that have done the incubation model well. Check them out if you’re looking for inspiration.

If you’re looking for other startup studios, here are a few with members in Confluence.

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✅ How to Win Your First 10 B2B Customers: How some of the best companies have done it

🔮 In Service of Founders: David Senra explains his passion for understanding the best founders in history

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- Clay and Tyler

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