Hello world, and welcome to the tenth issue of Thursday Thoughts.
Each week, founders and investors share their thoughts on fundraising trends and strategy.
1confirmation was launched in 2017 by Nick Tomaino and has established itself as one of the best funds in the space. They’re early investors in Index Coop, Notional, SuperRare, and OpenSea.
Richard Chen joined in 2018 and was recently promoted General Partner when 1confirmation announced Fund III.
Richard sat down with us and dropped a ton of knowledge about how he thinks about investing.
You recently tweeted that allocation size was much more important than investing in good deals. Can you elaborate on that? How do you think about sizing?
If you ask any VC who’s been investing for over a decade what their biggest lesson was, most will say they underestimated the importance of portfolio composition and sizing. The reason being that venture returns follow a power-law distribution, and in the uncommon situation where you hit a home run, you need to have a concentrated allocation for that investment to return the fund many times over.
A good rule of thumb is 1-3% of your fund size for each new investment and at least half reserved for follow-ons, with each investment having the upside potential to return the fund. Even if you hit a 100x+ home run, a small check like 0.25-0.5% of the fund won’t move the needle much for fund returns.
A common mistake that investors make is writing lots of small “spray and pray” checks to “get access to shots on goal” with the plan of doubling down massively later on if a project is successful. What actually happens in practice is the larger funds that lead later rounds will take almost all the allocation, so the earlier investors are fighting over the remaining scraps of allocation. Hence deals are less zero-sum the earlier you invest.
You recently invested in Visor Finance, which is an anonymous team. How did that impact that investing process? What advice would you give to anonymous founders raising money?
The team is very crypto-native and has been around this space for a long time since the Ethereum ICO, and the product was quickly getting traction. Being anonymous didn’t matter much since we look at substance rather than credentials. For anonymous founders looking to raise, this is a good thing since you don’t need to have a “Silicon Valley” polished resume and can just show how the product you’re building is better than other competing approaches.
The actual investment process was just deploying an escrow and vesting contract so the token swap could be done trustlessly on-chain without signing any legal documents. Though I can see how anonymity could be an issue for funds that have stricter LP agreements.
1confirmation has a concentrated portfolio relative to its fund size. Do you think you do more diligence than your peers who have larger portfolios?
We have a high bar for new investments because we like to work very hands-on with portfolio founders post investment (see more details in the next question). Offering first-class service is really only possible if you have a small concentrated portfolio, and it’s harder to give founders enough attention if you have 100+ companies in the portfolio. Likewise, our approach leads to a “high precision, low recall” investment strategy. “High precision” meaning that each investment we make usually ends up doing pretty well, but “low recall” meaning that we inevitably pass on a lot of deals that end up being good investments.
It's been awesome to see you build products for your portfolio companies (Dune Analytics charts for Hop Protocol and SuperRare, tracker website for Nexus Mutual). How do you spread your time across the portfolio? How hands-on do you think most crypto investors should be?
VCs with technical backgrounds who build for their portfolio projects are super underrated. The SuperRare Twitter bot has been a great marketing tool for SuperRare to engage with its passionate community, as artists are generally “touchy-feely” and love to comment and share other artists’ sales. Nexustracker.io has been a great resource for Hugh (CEO of Nexus Mutual) when talking to traditional insurers, who are blown away by how balance sheet data is all publicly available on-chain in real-time rather than hidden in quarterly PDFs.
As there is an increasing number of funds investing in this space, winning deals rather than picking good projects will become the more important skill as a VC. Offering first-class service is something good founders really appreciate – whether that be building Dune dashboards and liquidation bots, being an early liquidity provider, helping on token economic design and regulatory issues, retaining tier 1 auditors for the portfolio, etc.
One thing we like to do is let new founders reference check our existing portfolio founders and ask them, “Who is your most helpful investor?” Our existing founders will almost all say 1confirmation, and thus so far we’ve had a 100% success rate in founders accepting our term sheet over other offers.
1confirmation recently participated in The Index Coop's Treasury Diversification deal. We've seen a large increase in the number of treasury diversification sales like this one - what deal terms do you think are generally fair for sales like that?
The Sushi treasury diversification drama largely focused on the perceived “unfairness” of VCs getting discounts, but that’s focusing on the wrong issue. Rather, treasuries should only diversify with long-term funds that aren’t going to sell for years after their tokens vest, and not traders pretending to be VCs that are just looking to buy at a discount and flip. Once a project aligns itself with the best long-term partners then the actual discount terms and vesting schedules vary depending on things like liquidity and product traction.
Thanks again for your valuable insights.
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See you on Tuesday for Dove Dispatch #14,
Pierre