A love letter to micro funds, the backbone and future of venture capital

While the Sequoias and the Andreessen Horowitzes of the world continue to swell in size, their influence on venture capital may be heading in the opposite direction as micro funds increase their impact on the industry.

Whether you define micro funds as below $50 million or sub-$25 million, these are truly the funds that power the future of the industry. They help venture hubs take off, bring expertise and specialization to the market, and fill a role in the venture capital ecosystem that larger firms simply can’t.

They also can be credited with getting a lot of the large unicorn and public companies we know today off the ground, as many of them received some of their first dollars from a micro fund: Robinhood (Elefund), Coinbase (Initialized Capital, which was investing out of a $7 million fund at the time) and Flexport (Anorak Ventures).

I’ve written about the rise of micro funds in the U.S. before, but when Sweetwood Ventures reached out to me a month ago about its new fund-of-funds strategy to back nano — sub-$15 million — funds in Israel, I was intrigued. I hadn’t realized that the explosion of micro funds extended beyond the U.S. market, but Sweetwood general partner Amit Kurz told me it was one he had been tracking for a few years now.

Data from PitchBook shows that in 2021 alone, at least $16.8 billion was raised by micro funds, less than of half of which was raised by funds in the U.S. Sure, this total pales in comparison to general venture fundraising — which clocked in at $147.2 billion in the U.S. alone, according to the same source — but is a meaningful chunk of change for these small funds that can punch above their weight.

“These micro funds are the lifeblood of venture,” PitchBook senior venture analyst Kyle Stanford told TechCrunch. “[They are] often the first investment in a company, which creates more opportunity in the [venture] lifecycle. Especially when we talk about how much capital has gone into the venture market, it wouldn’t have been possible without the high number of micro funds.”

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Stanford added that the smallest funds serve as a significant source of capital to help pre-seed and seed-stage startups get off the ground and become ripe for funds from larger VCs down the line. They also help fill gaps in the market that a larger fund really couldn’t do.

Just the right size

An example of where small funds can drive outsized impact is geography. While funds in Silicon Valley can raise billions, they also have a matching number of startups to deploy to if they choose to keep their cash local. A fund in Tokyo, not so much. Stanford said that these smaller venture markets not only can’t sustain large funds — yet — but the risk profile wouldn’t make sense and a failure of a big fund in a nascent market could be devastating to future growth.

PitchBook found that countries like South Korea, Japan and India have all seen numerous funds raised over the last few years, which makes sense; while they all have sizable economies, they still have relatively small, emerging venture markets.

The small size also allows these funds to specialize in niche areas. Sure, you can delegate a $1 billion fund for climate tech, but you can’t really raise a $1 billion fund for companies that make wildfire tech specifically. But a micro fund? Absolutely.

These specialized capital pools can be tremendously helpful to their portfolio companies in ways that strict financial backers can’t. For Maxwell Brodie, the co-founder and CEO of wildfire tech company Rain Industries, having wildfire-focused Convective Capital as a backer also brings legitimacy to the category for larger and later-stage investors down the line.

This was echoed by the founders backed by Countdown Capital, a $15 million micro fund focused on hard-to-build, capital-intensive tech. Founder Jai Malik told TechCrunch he founded Countdown because he noticed larger firms would back companies in this category at later stages, but not at pre-seed, which meant many good startups were dying on the vine.

Small fund, smaller risk

For Sweetwood’s Kurz, he said this specialization was part of the reason he got interested in backing these micro funds as an LP to begin with: He noticed they were getting into competitive deals thanks to their expertise instead of their check size.

Fund of funds Sweetwood Ventures bets big on VC’s smallest funds

“They really generate this access to the most oversubscribed rounds and they invest a small amount, which is a classic win-win situation,” Kurz said. “You aren’t competing with the main VCs, yet everyone wants you because you are bringing a ton of value.”

It also allows LPs to gain exposure to emerging markets or differentiating strategies without a huge financial commitment.

The small fund size further decreases risk for LPs, too — not eliminating it, though, of course. It’s much easier to make one’s capital back in returns on a $15 million fund versus a $4.5 billion fund. They also can pull from a larger set of LPs, Stanford said, because they don’t have the investment minimums many large funds have.

“If you are a large fund, you aren’t taking money from family offices or small foundations,” Stanford said. “With a small micro fund, you have a larger base to raise from.”

Future funds

But micro funds are currently having a tough time raising. While there has been record venture fundraising this year more generally, that money has largely been concentrated in the big funds run by the legacy firms.

For firms like Sweetwood, this dynamic could help them get into funds that may have otherwise been crowded, but it will likely stifle micro fund growth at least for a while — but probably not for too long. When valuations really stop dropping and track records start getting tarnished, these small funds may look like safer places for LPs to put their money.

Hopefully so, as the growth of micro funds helps the industry expand into new geographies and new sectors and brings needed expertise to complicated problems startups are trying to tackle. The industry would be smarter and better off for it.