Nov 21, 2022, 10:42 AM ETInterview

Semil Shah: Lessons Learned Scaling from a $1M to a $50M Fund | 20VC #951

Haystack manages two recent funds at $50 million each, utilizing a "rinse and repeat" strategy to maintain operational simplicity and reduce variability for Limited Partners (LPs).
Future funds will modestly grow but remain strictly under $100 million to avoid diluting ownership stakes at exit and to avoid the obligation to lead every deal.
Average initial ownership in recent funds is approximately 7%, with a target range of 5% to 10%, ensuring founders always retain majority voting control.
Median entry points for Haystack deals cluster between $3 million and $15 million, though Sam Semmel notes the $3 million "on $15 million" cap round has become the standard median due to inflation over the last decade.
Fund deployment cycles have tightened to a 24-month window, down from the previously targeted 30–36 months, to align with current market speeds.
The firm targets a 10% ownership goal at exit across a 25-name portfolio to ensure meaningful returns without requiring massive fund sizes.
Semmel has rejected preferential terms (e.g., lower management fees or higher carry) for early investors, viewing such deviations as setting dangerous precedents for future funds.
Haystack does not employ hurdle-rate kickers (e.g., 25% carry above 4x returns), preferring standard 20/20 terms to maintain alignment with institutional LP expectations.

Semmel distinguishes between "talent" and "entrepreneurialism," stating that high-level product executives from major tech firms often lack the "hungry" grit required for successful founding roles.
The firm actively avoids "hot seed" rounds dominated by competitors like Andreessen Horowitz and Sequoia, viewing these often as low-urgency environments with poor directional focus.
Selection criteria prioritize "uncivilized" founders who demonstrate a history of overcoming adversity, rather than those with polished corporate resumes.
Semmel admits to a significant error in Fund IV (2017–2019), attributing 80% of its failures to poor selection and 20% to adverse selection when chasing ownership percentages over deal quality.
The firm views fund performance as a long-term game, noting that even a "turd" fund can be offset by 5–10% positions in three to four eventual public companies.
Semmel advises emerging managers to deploy angel capital on AngelList for 12–24 months to build a tangible track record before approaching institutional LPs.
Successful fundraising requires being in the "chatter zone"—building a reputation where other GPs and LPs actively recommend the manager—rather than relying solely on pitch decks.
Semmel blocks LPs who demand excessive contractual protections or changes to terms prior to raising, viewing such behavior as misaligned with the partnership model.

Institutional capital is becoming polarized ("barbell effect"), with endowments favoring either ultra-premium brands (e.g., Sequoia, a16z) or small, specialized funds (e.g., $50–200M) while avoiding mid-tier generalists.
LPs are increasingly concerned about "stranded capital" in large, slow-moving funds, driving demand for smaller vehicles that can deploy quickly and offer higher ownership stakes.
New capital sources are emerging from Middle Eastern entities (Saudi Arabia, Kuwait, Qatar) responding to high commodity prices and a desire to invest in innovation.
Semmel predicts a contraction in mid-tier VC funds (those with 10–15 partners and bloated structures) as they lack the agility to navigate the current downturn.
The "sins" of the VC industry include fund size escalation for fee capture and lowering financing milestones, resulting in companies hoarding cash without product-market fit.
A major risk factor identified is the potential for prolonged portfolio devaluations, with Semmel noting that M2 money supply levels are near Depression-era lows.
Semmel observes that LPs often fail to realize that "bucketing" capital by geography or sector can lead to adverse selection, forcing them to invest in the first available mediocre fund rather than the best manager.
Forward-looking statement: Semmel expects the "magic" of early-stage investing to be best preserved in funds of $100–200 million that can bridge the gap between pre-seed and Series A with sufficient firepower.

HashiCorp was the single biggest returner for Haystack, with a $25,000 seed check transforming into a distribution valued at approximately $30–35 million.
OpenSea is cited as the firm's biggest miss; Semmel declined a stake because he failed to understand the NFT model at the time, acknowledging it as a "mistake of omission."
Semmel has recently begun marking down portfolio values in Q3 reports, anticipating significant write-downs (potentially 30–50%) for early-stage assets in the current economic climate.
Recent investment activity includes a bet on InPart Security (a collaboration tool for security teams) and a strategic redirection of a deal to a specialized sector fund, prioritizing founder satisfaction over deal control.

Semmel's primary professional motivation is a fear of being unable to participate in the ecosystem, driving him to stay in the Bay Area and engage directly with founders.
He rejects the "passenger seat" competition, preferring to teach founders how to choose partners and acting as a flexible co-investor or lead depending on what benefits the company.
Semmel advises against over-reliance on decks for fundraising, emphasizing that "chatter" and referrals are the primary drivers of LP commitments.
The most stressful period of his career was raising the first four funds, which were under-subscribed and required continuous, exhausting fundraising cycles with no breaks.
Semmel values "good deals" as the singular piece of advice he takes from Paul Martino, emphasizing simplicity over complex strategies.
He identifies "respecting the money" as a critical metric, noting that founders who fail to provide transparent, regular updates struggle to secure follow-on capital.