Firm > Fund

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Welcome back to our “Idea of the Week” series. This week we’ve got David Haber, on the difference between a “fund” versus a “firm” and why choose the latter.

Firm > Fund

David Haber

I believe that most investors are running funds, and very few people are building firms. What do I mean by that? A fund, by my definition, has a single objective function: “how do I generate the most carry with the fewest people in the shortest amount of time?” Whereas a firm, in my definition, has two objectives. One is delivering exceptional returns, but the second is equally interesting: “How do I build a source of compounding competitive advantage?”

Funds get more fragile with scale. So building competitive advantage becomes existential if you want to build an institution that endures. The problem is, that isn’t how fund managers are encouraged to spend their time or their focus. Most funds are run by an alpha decision maker who oversees all investments. They spend most of their time thinking about the next marginal deal, and not much time thinking about their moats. Compensation structures reward investment returns, split among small teams.

Firms, on the other hand, are run by entrepreneurs. And entrepreneurs think constantly about competitive advantage. Many of the world’s great enduring financial institutions think this way. Apollo thinks a lot about compounding competitive advantage, with their permanent capital structures. Goldman Sachs has a compounding competitive advantage with the embedded distribution of their wealth management division, who can fill a new fund instantly. Firms like Renaissance Technologies, D.E. Shaw, and Two Sigma invested a lot into technology and data to give them an edge. Firms are product companies in this way: they have to build a product that wins in the market, that is defensible and isn’t obvious.

Firms also have more decentralized decision-making structures than funds. This is both by design (to build a 100-year compounding machine, you need a deep bench of leaders who you can trust with big decisions), and by necessity (because the CEO’s focus is on building a business, not on the next marginal investment.) When your competitive advantage is constantly changing, there’s a positive-sum project to work on (building and re-building your moat) that helps a loosely coupled org stay organized and aligned.

Venture Capital is almost always run in the “fund” model, with a small number of investors and often a single “alpha” decision maker. The fund spends its time thinking about its investments, since competitive advantage has historically been all about brand and reputation, which comes from the “human network effect” of backing great founders and returning legendary funds.

But since day 1 of Andreessen Horowitz, Marc and Ben have thought about VC as a product for entrepreneurs, rather than as a fund to manage. And so they’ve built a16z much more like a firm that builds products, decentralizes its decision-making, and thinks obsessively about new sources of competitive advantage. This gives a16z some unique characteristics:

1. We have entrepreneurs like Alex Rampell, Martin Casado, David Ulevitch and Chris Dixon leading their investment areas who you’d have a really hard time recruiting into a traditional fund model to work for someone else. Marc & Ben aren’t approving their investment decisions; they’re busy running the firm, so those leaders get genuine autonomy to make investments and build their teams. They get their own P&L, their paintbrush to paint a masterpiece, and the entrepreneurial freedom to shape their products to best serve their customers (entrepreneurs).
2. We’ve invested a huge amount into “platform”, which is a product for founders to accelerate their hiring, marketing, sales, and more. This is our war machine that we put to work on behalf of our founders, to use our scale to tilt the board in their favor. This platform costs hundreds of millions of dollars a year in expenses; it’s not cheap. But we do it because it’s a source of durable competitive advantage that a “fund” could never justify making. (Many of our competitors talk about their “platform team”, but they often mean the two people doing recruiting, and a marketer. We have 400 people who spend all day helping companies win. These are not the same!)
3. Therefore, because the firm is full of entrepreneurs and resources and product leverage, we can react quickly and decisively when a new opportunity comes up to build competitive advantage, while still enjoying our compounding economics of scale. Everyone at the firm is focused on their contribution to the product, not just their share of the returns.

This is the kind of vehicle you want to build, if you want your institution to last 100 years.

For more on “Firm > Fund”, here’s Ben Horowitz last week with Jack Altman: