The interview below is part of a series from McGuireWoods featuring impressive emerging managers, as part of our ongoing commitment to the emerging manager community. To recommend an emerging manager for a future interview, email Jon Finger at [email protected].
Q: What led to the decision to raise your initial fund? What were the indicators that you were ready?
Dan Engel: I had built and sold a lot of different software and technology companies and played a major role in the revenue generation for those companies. I was looking to focus on being more passive from an investor standpoint for the next stage of my career as opposed to running or building companies.
I started doing a good amount of angel investing and had a lot of success with it. I decided I wanted to take things to the next level and started working with a few different venture capital funds as a venture partner.
Then 2020 hit. I was looking to do more with my time than be semiretired and working with a few funds. I really wanted to do what I’m best at and what I liked doing the most, which is managing money and putting it into private companies.
I thought it would be a lot more fun to go beyond our own family office and invest other people’s money — people I had worked with over the years. We took advantage of the fact that I and a lot of people I had worked with over the decades had expertise in customer acquisition and marketing. We had this differentiator we could bring to the table to get access to compelling opportunities in technology. We were able to offer to help these companies with something they need more of than just about anything else to grow their revenue, and it’s something they generally can’t get from other firms: help with customer acquisition and marketing.
Q: How did you think about assembling your team?
DE: That’s been an interesting evolution. For emerging managers, there are a lot of options out there that didn’t exist 10 or 20 years ago to outsource, automate and delegate services. We tried to initially rely on outsourcing for services like fund administration. Unfortunately, what we came to find was we needed our own staff to take the lead on these outsourced services. There were just too many errors and issues.
Now we have someone who handles finance. We have someone who handles operations and administration. Daniel Hedden and I handle the deal side, both finding opportunities to evaluate for investment and working with our investors. We have about 90 investors now. It’s been about 2.5 years since we started the fund, and that’s a lot of relationships to keep up.
Q: What were the most important considerations for you when choosing LPs to pursue for partnership?
DE: We’re a little unique, thanks to the marketing and customer acquisition help we’re able to give our portfolio companies. We specifically try to recruit LPs to our fund that can help add to our existing bench. Examples of folks we brought on who have been really helpful to our portfolio companies include the former chief marketing officer of CBS, the former chief marketing officer of Papa John’s and the former head of marketing for Adyen.
I’d say about half of our LPs are marketing gurus of one sort. We try to cover the bases in terms of having expertise for just about every channel for acquiring customers, whether it’s pay-per-click search, SEO, influencer marketing, B2B sales, content generation, etc. There are about 30 different areas companies turn to when they want to find customers profitably, and we have expertise in all these areas. We can help our portfolio companies fill in the gaps by having decades of experience in each of these channels through our LPs.
Q: What did you consider and prioritize when developing an investment strategy for your initial fund?
DE: In terms of the strategy, we invest in software companies that are early-growth stage. It’s those companies with $3 million to $50 million in annual recurring revenue, growing at 2-5x and with outstanding metrics around customer retention and satisfaction.
I think we landed on this sweet spot because I’ve dealt with so many early-stage companies as a serial entrepreneur over the years and being a part of other people’s companies. I’ve seen how getting product market fit can be such a mystery and often doesn’t happen.
As an investor, I wanted to skip that uncertainty. We come in when a product’s market fit has already been figured out, partly because the risk profile is completely different. It’s just a question of how much they will continue to grow, not whether they’re going to find product market fit. At this stage, you don’t have that same degree of risk around an investment that could become nothing.
Then it’s a matter of figuring out the chances the company can continue to grow at 2-5x over the next few years. We look at things like net revenue and client retention. What we’re looking for is not 85% year-over-year client retention or even 95%. It’s more like 99% or 100%. When we see those kinds of off-the-charts figures, we get excited. Same with Net Promoter Score. We don’t want 20, 30 or even 50. We want 95, and we’re fortunate to have a few companies around that figure. A company can grow in leaps and bounds continuously by not losing customers and being successful at attracting new ones.
Q: With emerging manager programs on the rise, what do you foresee with respect to LPs’ willingness to invest with emerging managers?
DE: It’s certainly tougher than it was in 2020 for raising money, which is when I started our first fund. As a result, I think there will be fewer emerging managers that can produce sizable funds. That’s become pretty clear when you see how much smaller funds are these days.
In terms of the appetite for emerging managers in this climate, there are always investors who can spot and appreciate those managers who have a different way of doing things — that can find their way into amazing gems of opportunities for investment. I still see that when I speak with LPs, family offices, fund of funds and the like. They’re looking for a special sauce. I don’t think that’s changed. They’re just not doing as many new investments.
LPs also have issues around being overallocated, especially because public equities have been reevaluated in terms of their valuation. Private ones, not so much. This has led to LPs being somewhat overconcentrated in venture capital or alternative investments. In many ways, it’s the same as it always is: Great investors are looking for special situations and managers who can find them.
Q: How did you approach raising a first-time fund?
DE: I first put out some feelers to people I thought were most likely to be interested. That gave me a sense of how we could get to a certain figure. Then it was a matter of where to go from there.
I didn’t set grand ambitions. I just wanted to continue doing what I was already doing for our own family office but do it with other people and have more fun doing it while making the work more social. Now, instead of just bragging to members of my family about how well we’re doing, we have 90 people enjoying the success. This brings me a great deal of joy.
Q: What is the best piece of advice you were given when raising your first fund?
DE: When people say no, move on. I would say, in our case, we move on temporarily, but we’ll come back when we have another fund or if we have a sidecar.
I think one of the challenges with emerging managers is you’re told you won’t make money for quite some time and only if you’re successful will you be able to do additional funds. In my case, money wasn’t the biggest driver. This is what I wanted to do with my time. I think with special purchase vehicles (SPV) and sidecars, they helped address that gap.
The management fees on a first-time fund are minimal, but when you combine them with having sidecars, which are kind of open-ended in terms of how big they can be and what kind of opportunities are included, you get a lot more leeway to find ways to make significant amounts of money from your first fund. In our case, we’re closing our 10th SPV, and we’ve only been around for about 2.5 years. These SPVs are all in companies we also invested in through the fund. If the fund writes a check for $1 million and there’s $1.5 million additional allocation available, we’ll fill it with our investors.
About Dan Engel
Dan Engel is the founder and managing partner of Santa Barbara Venture Partners (SBVP). He has been a B2B and B2C software entrepreneur since 1997 and has been a public securities retail investor since 1991.
Prior to launching SBVP, in addition to being an active angel investor over the past nine years, Engel was a venture capitalist-in-residence and venture partner at OCV Partners and NGEN Partners, with $261 million and $250 million venture capital funds, respectively. Prior to becoming a venture capitalist, Engel led customer acquisition for Google, GoToMeeting, Picasa and FastSpring.