Announcing CrossCut Ventures 3

The Trials and Tribulations of Building a VC fund to Scale in LA

It is with great pleasure and a bit of exhaustion that my partners and I announce the official launch of the 3rd fund for CrossCut — a $75M fund — with a focus on being the first institutional capital into the most scalable business ideas and entrepreneurs that this region is producing. For the last 8 years, we’ve been positioning this fund as the “company-building capital of LA” and now we are properly capitalized to execute on that vision.

This blog post will be the first of what we plan to be more consistent attempts to share our point of view on the venture ecosystem, building great companies, our job as VCs and the role we play in catalyzing the seed-stage market of LA.

We will do this with honesty, transparency and humility. We look for these qualities in our entrepreneurs, so the least we can do is practice what we preach and provide a lens into our world — the decisions we make, the advice we give and the things that really drive our business.

This is a little out of the norm for us. We consider ourselves to be company-builders, not bloggers or tweeters and we believe we should be measured on the quality of our portfolio, not the quantity of our tweets. It is most definitely out of our comfort zone, but seems to be the price of admission these days to establish your brand and have appeal to national and international LPs.

So, to get things started, I thought we’d share a little on the history of the fund and what, from our point of view, transpired over the last 6 months to bring this fund to market.

We started CrossCut Ventures back in 2008 with a simple idea: the SoCal tech ecosystem was emerging and there wasn’t a branded fund, properly positioned to take advantage of the businesses that it would spawn. Rick Smith and I had a front row seat, having managed several funds at Palomar Ventures together since 2001.

Between 2001 and 2006, we saw 20+ exits from LA and very few of them had any local VC backing. Companies like Jamdat, LowerMyBills, Pricegrabber, Shopzilla, FastClick and most notably, Intermix Media/Myspace (which is where Brett Brewer came into the CrossCut fold) all exited for $200M to $800M. Those companies started the flywheel spinning and have spawned hundreds of new start-ups, but there wasn’t enough capital in town with the right “product” to attract and fund those ideas. We started CrossCut to be that “product” — a catalyst for innovation in Southern California.

It was a great idea with interesting (absolutely horrible?) timing. The collapse in September of 2008 was dramatic and dried the well of institutional capital interested in new VC funds. We were fortunate to raise our first fund in August of 2008 — it was a $5M fund raised from primarily successful LA tech entrepreneurs that shared our vision for what LA could become.

We were undercapitalized, but filled with conviction that our thesis was right and that there would be a pile of great companies that would emerge from this market. Fast forward to today — 10 of our 18 investments in that first fund will return positive capital back to the fund. We’ve exited seven investments, while four of those companies have returned greater than 9X our original invested capital and we’ve already returned nearly $10M back to our investors. We still have three great companies remaining in our portfolio that we believe will drive additional multiples on the fund — JustFab, GumGum, and Verve Mobile.

Off the success of our well-timed exit from Shoedazzle and an early, but good-looking portfolio, we raised a $16M CrossCut 2 fund in 2012. LA was starting to mature, but it still had not received a lot of attention from institutional money. Mark Suster wasn’t quite the household brand yet and despite some great successes, companies like SnapChat and Tinder did not exist yet and the region had not yet captured the attention of Silicon Valley.

We talked to some institutional money while fundraising for CrossCut 2, but it was “too early” and no one had conviction about the region. So, what did we do? We put our head down and kept putting money to work behind passionate entrepreneurs building great companies. We were, and are, grateful for the support of the many entrepreneurs and friends who staked us in the first two CrossCut funds. We became their fund as well as our fund. It took a village.

It was no small feat to keep Crosscut alive and moving in the right direction. Brett Brewer was running around the country with his day job as President of Adknowledge and I was busy working with Allison Beal to launch StyleSaint. We were hustling — trying to look bigger than we were and taking what little spare time we had to meet the best entrepreneurs in town coming through our network here in LA. We still lacked a long-term office and were finding desk space in our portfolio companies, temporary space and various Coffee Beans. We had become the start-ups we were backing.

Nineteen deals later, we finished investing CrossCut 2 in September of 2014. It’s still too early to tell, but we love the way the portfolio has come together. We’ve obviously benefitted from a strong market, but most of our companies have raised significant follow-on capital from high-quality Silicon Valley VCs. Companies like Club W (Bessemer), The Black Tux (First Round and Menlo Ventures), Super Evil Mega Corp (General Catalyst and Raine), Data Science (Greycroft), Omaze (FirstMark), Inspire Energy, Narvar, Soma Water and Local ID are all growing well and hitting their revenue plans. We’ve also had some early exits in the fund with solid returns coming from Lettuce (Intuit), Gradient X (Singapore Telecom) and Dermstore (Target).

So, now to CrossCut 3. How did we end up raising $75M? This is a pretty significant jump from a $5M and $16M fund. When we made the decision to start raising CrossCut 3, we put $50M on the cover, thinking this was a reasonable target that we could achieve if we were able to attract institutional money. We also felt strongly that it was the right amount of capital for our strategy — concentrated ownership in 25–30 companies that all have the potential to be category leaders. This number was also chosen because we feel it is the right amount of dollars per investing partner. We now have 4 full-time investing partners (adding Clinton Foy as our 4th Managing Director — more on him later) and for our strategy, “hands-on company-building”, we feel strongly that a partner cannot properly manage more than 5–6 deals at a time. Most of the micro-cap VC funds end up with 10–20 deals per partner, which results in more of a “spray-and-pray” approach to investing where the partner may be spread too thin and can’t really contribute at any meaningful level.

Our mantra is “to be of service” to our entrepreneurs and it is very hard to do that if you are managing a large portfolio of companies.

So, with solid returns from CrossCut 1 and a nicely developing CrossCut 2 plus a growing awareness to what is going on in the SoCal tech ecosystem, we set off to raise CrossCut 3 in the summer of 2014. From our point-of-view, there is never a good time to go to market. Every LP seems constantly inundated with their current managers coming back to market sooner than expected and a desire to reduce their total number of manager relationships by triaging their portfolio down — to “trim the fat” of the underperforming tier 2 and tier 3 funds in Silicon Valley that have not been able to deliver returns.

As a generalization, fundraising from institutional LPs is 10X to 100X harder than raising capital for a start-up. Why do I make this claim? Because the many institutional LPs are managing assets across numerous asset classes (PE, VC, energy, real estate), have very little knowledge or true understanding of VC, are biased by Silicon Valley-centric media sources and, most importantly, have no financial incentive to take risk on something new and interesting. Like many of us, they all want to keep their jobs for another year. Their basic mindset is that they are less likely to get fired for investing in Kleiner X than they are for taking risk on new fund 1,2, or 3. In a nutshell, this is why the VC industry has continued to pour 80–90% of the capital into roughly 20 tier 1 mega-funds. There is safety in critical mass. Many people write and blog about the lemming mentality of Silicon Valley and the VC industry in general. Institutional LPs are no different.

Back to the fundraising…we hit the road hard starting in September. Our strategy was to circle up with our current investors and try to do a first close on their commitments so that we could start putting companies into the C3 portfolio. We’ve been fortunate to have a great group of investors supporting us since we launched the fund and we benefitted from their increased appetite in our new fund. Simultaneously, we began to travel around to engage with a select group of institutional LPs that have shown an appetite for micro-cap VC and new funds in general. Unfortunately, that list is not very long for the reasons I outlined above, but our plan was to introduce them to our strategy and differentiation and then build the relationship over the next several months, showing them our ability to execute. If you don’t walk in with a national brand and some Uber-like company in your portfolio, it is difficult to get serious interest. So, we tried to capture their attention with our returns and IRR numbers, but mostly start the dialogue about what we think differentiates CrossCut from the overcrowded micro-VC landscape.

In late October, we did the first significant close on the fund — roughly $30M. Almost all of this was from our current investors from C1 and C2, but we managed to attract additional individual investors and family offices that liked our results and positioning. We started investing CrossCut 3 and by the end of the year, we had 3 deals in the portfolio.

When we came back from the holidays, it was full steam ahead. We were extremely fortunate to start things off with Mark Suster and Upfront’s efforts with the Upfront Summit in late January. Every LP that had any interest in SoCal came to town and Mark was and continues to be extremely generous in making introductions on behalf of other local funds. No party outside of CrossCut did more to help us than Mark Suster. He had just finished raising his $285M fund and had current information on the likes and desires of many potential LPs in the country. Quite honestly, the Upfront Summit was the catalyst for our next wave of fundraising and it kicked off our serious conversations with institutional money about their potential involvement in CrossCut 3.

From February through the end of April, our lives at CrossCut have been pretty consistent. Rick and I have been leading the fundraising with regularly scheduled trips around the country — Chicago, NY, Philly, Dallas, DC, North Carolina and SF. Every couple of weeks, we line up a trip and reach out to the engaged LP list to line up a next meeting. If Rick took the first meeting, I would take the second — giving the LPs a reason to meet — a portfolio update or some progress or additions to the team.

Back at home, Brett, Clinton and Joe Guzel (our new Associate) focused on deal flow for the new fund. We were quickly growing the portfolio and many of our early investments were making good progress and raising follow-on capital. This played a huge role in our fundraising success as LPs like to see a few companies in the portfolio to get a sense for what they are investing in. In our case, we had a set of high-quality co-investors in our first few deals (Accel, First Round, Lowercase, Sequoia, LererHippeau, Founder Collective) and good signals coming from follow-on rounds led by NEA, Lightspeed, LowerCase and Raine. We also benefitted from additional liquidity and M&A conversations across the C1 and C2 portfolios.

All of this created momentum and there may be no more powerful force in the institutional world than creating the sense that they are missing out on something special. It is the same core human emotion that drives VCs into a deal — fear of missing out and the belief that this thing is going to make money.

So, here we are now near the end of June and ready to announce CrossCut 3. Over the last 4 months we’ve raised an incremental $40M. It is not our place to disclose who our LPs are, but we are thrilled to say that 80% of this capital came from 6 experienced institutional LPs with great reputations for being aggressive in the micro-VC space. They are a mix of Foundations, Endowments and Fund-of-Funds and they will be the foundation of CrossCut for the future.

If you saw our press release (here), you will also see that we formally announced the addition of Clinton Foy as our fourth Managing Director for the fund. The three founders (Rick Smith, Brett Brewer and myself) feel so fortunate to have found Clinton and convinced him to take the risk of joining a $16M fund. For the last two years, he’s hustled to prove his network and operator-orientation will be a valuable asset to CrossCut as we pursue investments across the gaming ecosystem. So far, his investments are looking good with SuperEvil Mega Corp, MobCrush, LittleLabs and Vulcun as the first four deals he is taking the lead on. Entrepreneurs love him and he is an extremely valuable member of the team and the culture of CrossCut Ventures.

So, now, everyone is up to speed. We have a new $75M fund, offices at 4th and Rose in Venice, 9 investments already in the portfolio (MobCrush, LittleLabs, HelloTech, ConversionLogic, Starmaker Interactive, Vulcun, CandyClub, OngoWorks and Tribe), 4 full-time investing partners, a kick-ass Associate (Joe Guzel, ex- Corp Dev at Intuit) and a full roster of Venture Partners — all ready to go to work on behalf of the passionate entrepreneurs in our portfolio.

Whether you are in LA, SD, SF, NYC or any other pocket of innovation, our flag is flying and we are ready to hear your vision for the future. Please come our way if you are looking for a team with deep operating experience in the areas of eCommerce, AdTech, Mobile, SaaS, Content, Marketplaces or Gaming.

We are excited to bring this fund to scale and promise to continue our mission of stimulating innovation in the early-stage tech ecosystem.

Looking forward to an ongoing dialogue . . .

-Brian Garrett