In today’s episode, Andreas Munk Holm talks with Ertan Can, the Founding General Partner of Multiple Capital, a venture capital fund based in Luxembourg. Together, they delve into how micro funds work and why they’re becoming an attractive investment option for limited partners.

Ertan discusses the role of manager selection and the benefits of a diversified micro-fund portfolio. He outlines LPs' challenges in sifting through hundreds of emerging funds each year, noting that a disciplined approach is needed to identify the best opportunities. The discussion also touches on the influence of local networks and market niches in sourcing high-quality deals and future trends in venture capital, highlighting how a strategic focus on micro funds may offer more sustainable and robust returns for LPs.

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Ertan’s presentation shows that many funds delivering 3x or even 5x returns come from smaller, emerging managers. He points out that even though traditional databases like PitchBook sometimes miss these micro funds, the data consistently shows that most high-performing funds are on the smaller end of the spectrum.

He explains that micro funds benefit from being agile and focused, which allows them to capture opportunities that larger funds often overlook. This nimbleness, combined with the ability to operate at lower thresholds, gives these funds a competitive edge, resulting in superior performance over time.

Ertan breaks down the math behind fund returns by showing that smaller funds don’t require billion-dollar exits to generate impressive multiples. He uses real-world examples to explain that while a larger fund might need an exit in the billions to hit its targets, a micro fund can achieve similar multiples with much more modest exit figures.

This lower exit valuation requirement makes micro funds especially attractive, as the path to success is more accessible and realistic. The concept is straightforward: less capital at risk means strong performance is achievable without the need for outsized returns on every investment.

As Ertan notes, one major advantage of micro funds is their lower management fee structure. Typically charging around 2% to 2.5%, these fees are considerably lower than those often demanded by larger funds. Lower fees mean that a higher percentage of the profits goes directly back to the LPs.

This fee advantage can compound over time, significantly boosting net returns. By keeping overhead costs down, micro funds ensure that investors retain more of the value created, making them an appealing choice for those looking to maximize their returns.

Ertan stresses that the secret behind micro-fund success is picking the right managers. With a flood of new, emerging managers in the market, it becomes essential for LPs to invest time and effort in thoroughly vetting these managers to identify the best opportunities.

He emphasizes that even the most promising micro funds could fall short without careful manager selection. For LPs, this means dedicating considerable resources to meeting and evaluating hundreds of potential funds yearly or relying on fund-of-funds specializing in this rigorous process.

Diversification is key when investing in micro funds, and Ertan recommends spreading bets across 5 to 10 funds per vintage. This strategy helps reduce the risk inherent in any single investment while capturing a broad range of opportunities in different niches or regions.

By diversifying, LPs can reduce the volatility of investing in early-stage or specialized funds. The idea is to create a balanced portfolio where the occasional high performer can more than compensate for the others, ultimately leading to a more resilient overall investment strategy.

One of the toughest parts of investing in micro funds is the sheer volume of opportunities. Ertan points out that LPs might have to sift through 300 to 1000 funds each year to identify a handful of solid investments. This process is both time-consuming and resource-intensive.

Moreover, standard data sources like PitchBook don't capture many micro funds, making the screening process even more challenging. This laborious task often leads LPs to consider partnering with specialized fund-of-funds, which can streamline the process and ensure that only the best opportunities make it through the selection process.

Ertan discusses how the venture capital landscape is rapidly evolving, with some mega funds growing to almost unimaginable sizes. These larger funds now need to secure astronomical exits to meet their ambitious return targets, which adds a layer of risk and uncertainty.

In contrast, micro funds offer a more sustainable model with lower exit requirements and nimble investment strategies. As the market shifts, LPs may find that a well-diversified portfolio of micro-funds can provide a balanced alternative to the high-stakes world of mega-funds, potentially delivering superior returns with less risk.

The discussion also raises the risk of over-relying on well-established networks. While strong local and industry networks can provide excellent deal flow, they can also lead to a narrow view of the market, where only the most well-known opportunities circulate.

Ertan warns that this network bias can result in adverse selection, where promising underdogs from less connected areas are overlooked. To counter this, LPs must expand their horizons and adopt a more comprehensive approach to scouting and evaluating managers, ensuring they capture the full spectrum of potential investments.