Mature and mega VC firms typically don’t place early-stage bets but instead focus on companies that have already achieved some success. In other words, rather than bring new ideas to market and help them grow, these firms prefer to invest in already proven businesses. That’s where micro VCs come in.
Micro VCs are small, nimble firms focused on investing early in companies with high growth potential. Defined as funds smaller than $50- or $100 million, micro VCs play an essential role in financing and incubating new businesses. By taking on more risk, they provide critical funding at a pivotal moment in a company’s development.
Micro VC Outperforms
By investing in seed and early-stage companies, micro VCs can achieve superior returns. While performance data specific to funds smaller than $100 million is hard to come by, a study of VC performance over 20 years provides some insight.
As Cambridge Associates data shows, return multiples have consistently been significantly higher for smaller funds. In other words, small VC firms have outperformed their larger counterparts. The physics of capital markets would indicate that this should be the case. When firms are small, they generally invest in companies earlier in their development cycle and have more room to grow.
This outperformance is also clearly seen in the net TVPI of new and developing funds by vintage year. The data shows that new and emerging funds are consistently among the top performers.
Further, as Preqin data shows, eight of the ten top-performing venture capital funds have fund sizes of $100 million or less.
Why? There are a few reasons. Beyond the physics of capital markets, smaller firms usually have a different focus and strategy than larger firms. They’re often sector-specific and deeply understand the companies in their domain. Additionally, they tend to be more founder-friendly, providing not just capital but also mentorship and resources. And because they’re often investing alongside angel investors, they’re typically more attuned to the needs of early-stage companies.
Speed is another advantage that micro VCs have over larger firms. They can move quickly to support companies that are gaining traction and need capital to scale. This agility allows them to capture opportunities that others may miss.
The Micro VC Opportunity is Growing
Several factors, including the proliferation of technology, the globalization of markets, and the rise of the entrepreneurial economy, have fueled micro VCs.
As technology has lowered the barriers to entry for starting a business, entrepreneurs have more opportunities to bring new ideas to market. At the same time, globalization has created a more level playing field, making it possible for businesses to scale quickly and reach new markets.
This environment is perfect for micro VCs, which are well suited to spotting and backing the most promising companies. And as the number of micro VCs has grown in recent years, so too has the amount of capital available for early-stage companies.
PitchBook data highlights the precipitous rise in the number of micro-funds closed annually, growing “from an average of 75 each year between 2006 and 2011, to an average of 320 each year between 2018 and 2021.”
The AUM of micro VC firms has also exploded, increasing from just over $10 billion in 2011 to over $60 billion in 2021, according to the same PitchBook report.
This growth is driven by several factors, including an increase in LP interest, the rise of new micro VC firms, and the launch of funds focused on early-stage companies. As more capital flows into the space, we’ll likely see even more growth in the coming years.
The rise of micro VC is highly correlated with the rise of seed deals, and seed deals have become increasingly attractive to investors. The most obvious reason is the opportunity for spectacular returns.