I want to follow up on yesterday’s post about larger VC funds creating a dilemma for established firms. I chatted with an emerging manager recently. Raising his first fund wasn’t easy. After eighteen months, he hadn’t hit his $25 million fundraising goal and stopped at $10 million. That first fund is performing well, and he went out to raise his next fund a few years later. He wanted to raise $50 million but ended up with $60 million because of outsize demand from limited partners who wanted to invest at the ground level of amazing companies.

When we spoke, he was happy the second fund is larger but, at the same time, on the horns of a dilemma: he can’t deploy fund 2 using the same strategy he did with fund 1. He gave me some simple math. (Note that he ignored reserves for follow-on investments and other variables for the sake of getting his point across.)

He wants to invest at the ground level and aims to be the first check or in the first round of capital raised by early companies. From fund 1, he could write a $500k check—5% of his $10 million fund. He could make 20 of these investments, which is achievable, and deploy the full $10 million. The valuations were reasonable, and if one investment performs well, it could return the entire $10 million fund.

With fund 2, though, to write 20 checks each representing 5% of the fund, each check must be for $3 million. But the early companies he targets don’t need $3 million! Their first rounds are usually much smaller.

He now must choose among what he views as not great options: overcapitalize 20 early founders with $3 million at inflated valuations and negatively impact fund returns, stick with $500k checks and find 120 companies, do a hybrid of the two, or invest in 20 slightly later-stage founders (i.e., not at the ground level) at reasonable valuations.

This manager has done a great job of finding, capitalizing, and supporting founders during the earliest part of their business cycle. He’s successfully investing at the ground level of some amazing outlier companies. His strategy worked well for fund 1, which led to fund 2 being larger. He now must adjust his strategy because of the larger fund size, which could hinder him from supporting founders at the ground level. The math (simplified here) demonstrates how raising a larger fund can complicate backing founders at the earliest parts of their journey.