128. Sector & Niche Focused Funds, p2 and Driving Value with a Regulatory Focus (Jordan Nof)

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Today we cover Part 2 of Sector & Niche Focused Funds with Jordan Nof of Tusk Ventures. In this segment we address:

  • Given the current regulatory environment, are there specific verticals that you find particularly compelling?
  • Do you expect more micro VCs, niche and sector focused funds to launch in the coming years?
  • Tell us more about the various ways that you specialize at Tusk.
  • When is the right time to start interacting with regulators?
  • What are your thoughts on working with regulators at the federal vs. the local levels?
  • Do you have any advice for founders and/or investors re. today’s topic?

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Key Takeaways:

1- Types of Specialties

1. Corporates: These are the venture funds created within large organizations with a focus on taking equity positions with early stage companies that pose a threat to their existing P&Ls or create opportunities to expand and grow their business.
2. Vertical/Sector: These include funds that invest exclusively in Real-estate, Insurance, Healthcare/biotech, or any other industry sector.
3. Niche Focused: These are funds with a horizontal strategy that offer some strategic value add. They may be bridging a gap or filling a need that hasn’t existed across the funding landscape. Bullpen is the example that Jordan cited, where they’re providing that pre-A financing need. In some cases, you will find firms specializing based on geography, stage or strategy. The key distinguishing element has to do with the value. Investors and founders alike should ask, “Is the firm investing in this niche because the GP can drive unique value?”

2- Benefits & Drawbacks of Niche-Focused Funds

-Allows the investor to gain access to deals that could be highly competitive… if you have a focus area, you can provide strategic value that other, generalist, investors can not. This can help a small firm earn an allocation in some of the most competitive deals.
-Tighter mandate reduces a lot of the dealflow noise that you see; creating significant efficiencies over the generalists
-Tremendous opportunity for knowledge sharing between niche fund portcos. Some of the best value exchange happens between founders operating businesses with distinct parallels.
-Jordan cited the benefits of information asymmetry. And he gave the example of an LP-base that can provide strategic value and insight during startup evaluation. Also, in some cases, the LPs may be potential strategic acquirers.
-Finally, on benefits, we discussed messaging and developing a brand. When an investor has a distinct mandate, they can message clearly to both founders and to upstream or downstream investors. This creates a brand association for the firm, allowing for much more targeted partnerships.

-Lack of diversification. When one invests in the same area over and over again, they will not have the same degree of diversification as generalist investors.
-There’s the risk of conflicting yourself out. I’ve heard many investors reflect on having to pass on investments in great opportunities b/c the timing is wrong or they believe another solution will be created to better address the problem. Imagine being an early investor in Myspace and having to pass on Facebook.
-Lack of noise that we cited as an advantage can also result in a lack of opportunities. One could miss out on the biggest and best deal that comes their way b/c it was not in their focus area.
-Jordan discussed how sectors can get hold and cold. When sectors get overheated, competition for allocations and valuations increase, while when sectors cool, there can be a lack of institutional LP capital interested in investing.
-Jordan’s final point on drawbacks related to the lack of track record that is often the case w/ niche focused funds. Because most specialized funds are new, micro-VCs, that also typically means that there is little or no track record for the GP. Or it could be a thesis on a new area that hasn’t fully matured, so LPs have to take a risk on a new fund manager in an emerging area, which can present too munch uncertainty for them to get comfortable.

And Jordan reminded us that a firm need not restrict itself too much preventing high-potential, opportunistic investments. In his example, if Travis Kalanick came to him with a new startup, regardless of the circumstances, Tusk would not hesitate to invest. So, even the best niche-focused funds build in some flexibility for situations outside of their mandate.

3- Suggestions for sectors with significant regulatory exposure

Jordan said that “regulation always lacks innovation” and in light of that he had a number of wise points to consider w/ regards to regulatory, including:
-Study the regulatory risks that exist in your vertical focus area. Risks can present opportunities if one is knowledgeable and prepared for those risks. But it’s not advised to be investing in a sector without an awareness of the regulatory climate.
-Get involved early. Here Jordan talked about the importance of working with the regulatory officials to establish guidelines for areas that aren’t currently addressed by the regs. When both sides understand each other’s needs, he’s found that strong progress can be made toward a common goal. The regulators do not exist just to maintain the status quo.
-Jordan mentioned that many of the regulatory battles are fought at the state and local level. While the perception is that most issues are federal but, from Jordan’s experience, he finds that much of the time these issues play out in smaller jurisdictions.
-Some of the industries that Jordan mentioned that really interesting from a regulatory standpoint included: Insurance, cannabis, 1099 workforce-related sectors,
-Where there is significant regulatory exposure, it may be best to partner with another investor or an agency that has real expertise in managing the reg environment.

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