Why I Backed A GP Without VC Fund Due Diligence

I committed to a VC fund without opening the data room the GP sent me. It sounds careless, but after you read this essay, you may change your mind about VC fund due diligence, and adopt a complementary set of tools.

LPs evaluating Venture Capital funds typically rely on track record, using past performance as an indicator of future returns – a principle called persistence. Yet, evidence of persistence in VC fund returns remains inconclusive. Past performance may say less about the next fund’s potential than most LPs assume.

So the question is: how should LPs evaluate VC funds before they commit?

In a recent chat with Martin Tobias, a veteran entrepreneur and Angel Investor now raising his Fund II, I laid out how my framework, Mindset-Based Investing, can help LPs select VC funds with limited recourse to track record data.

Caveat: I wouldn’t have done it if it wasn’t my own money. Professional LPs’ fiduciary duties compel them to carefully analyze all the data.

I hope you enjoy our talk. I added links to research backing this approach in the summary below, including my report: Emerging VCs: Selection Through Mindset.

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Topics Covered

Martin and I discussed a series of topics. The main ones are summarized below. Watch the video for more details.

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How Power-Law Masters Make Decisions

Watch from 01:52

We first talk about my approach to better allocate capital in venture. Mindset-Based Investing grew organically from hundreds of hours analyzing how the best venture Investors make decisions. The concept almost imposed itself on me. When I started teaching Venture Capital, the same question kept coming back: how can I make better decisions? I listened to Brad Feld, Fred Wilson and the few Investors who had generated $1 billion outcomes more than once. I now call them Power-Law Masters. Their decision process seemed to have three moments. An intuition appears. They pause it and look for evidence that could prove it wrong. Only then do they decide, with the upside firmly in view. Mindset-Based Investing grew out of that observation.

Why Intuition Breaks In Venture Capital

Watch from 06:38

Why not follow your intuition right away? We next tackle the role of intuition in Venture Capital decision-making, using poker as an analogy. Domains like poker, chess, and firefighting lend themselves well to expert intuition – fast pattern recognition developed through repeated exposure to valid cues and reliable feedback. However, Venture Capital provides neither condition consistently. Similar Founders can build similar companies and produce opposite outcomes because timing and luck interfere. The feedback also takes years. Seeing thousands of deals creates recognition, but recognition alone does not create reliable judgment. Pattern matching can therefore feel more authoritative than it deserves. The first intuition about an investment opportunity could prove useful, but it still needs to be tested. Read my report on intuition in VC for more details.

Why LPs Are Leaving Money On The Table

Watch from 09:19

Mindset-Based Investing applies at every capital allocation step in Venture Capital. It can help GPs select Founders, but also help LPs allocate capital to GPs. This becomes particularly useful with Emerging VCs, where conventional evidence is thin. Fund I and II managers have little realized track record, which makes many LPs shun them – even though most of the top-performing funds by vintage years are Funds I and II. I call this the Emerging VC conundrum: the segment offers exceptional potential returns while giving LPs little conventional data to select its winners. To address it, I worked with three MBA researchers and studied how Beezer Clarkson, Michael Kim and Samir Kaji evaluate new managers. We found six recurring rules and traced each one back to mindset. In my conversation with Martin, I described four rules LPs can use when evaluating Emerging GPs.

VC Fund Due Diligence Rule #1: Evaluate The Entrepreneur First

Watch from 12:45

That led me to my first rule for Emerging GP due diligence. A new GP is building a business before managing an institution. In other words, he or she is a Founder first, and Investor second. For instance, I look closely at how that person spends time. Is the thesis being tested with Founders? Are live investments improving it? Is the fund sized to prove the strategy? Or is most of the energy going into conferences, lawyers and fundraising theater? Many Emerging Managers spend most of their time traveling to LP resorts and never raise the fund. The evidence I seek in a Founder matters here too: focus, resourcefulness and proof of work.

VC Fund Due Diligence Rule #2: Judge Decision Quality, Not Outcomes

Watch from 17:14

When Martin sent me his data room, I never opened it. I watched his interviews, spoke with him, questioned him at my SXSW event and studied how he reviewed the investments he had passed on. I cared about the reasoning that came before the outcome. A good result can come from a poor decision, just as a sound decision can be unlucky. Martin told me that twelve companies in his portfolio had become unicorns, but he considered six of them lucky. He built his strategy around the six that reflected an advantage he believed he could repeat.

VC Fund Due Diligence Rule #3: Find Investors Who Are Trying To Win

Watch from 23:20

Later in the conversation, Martin brought me back to the third part of the framework: promotion focus. The best Venture Capitalists tend to ask what can go right. They tolerate being wrong because the upside of the rare correct decision is so large. Martin showed that posture. He was comfortable with ambiguity, willing to be contrarian and able to explain a view that did not depend on consensus. I did not need certainty that he would be right. In Venture Capital, conviction can become self-persuasion. I needed enough confidence in his decision process to make a sensibly sized bet. I described the fuller case in my earlier profile of Martin.

VC Fund Due Diligence Rule #4: Look For Resilience, Not Stubbornness

Watch from 27:59

Grit is useful until it becomes a reason to keep doing the same thing. That distinction matters in Founders and GPs. Venture Capital guarantees obstacles. A thesis, sourcing channel or portfolio plan will eventually meet evidence that contradicts it. I want to see what happens next. Resilient Investors absorb the failure, revise the approach and keep moving. Stubborn Investors preserve the approach and call the repetition conviction. Outcomes will still depend partly on luck. The ability to learn from failure is one of the few qualities that can compound before a track record does. I compared grit and resilience in Founders in this article. Much of it applies to Investors.

What LPs Should Know Before Allocating To Venture Capital

Watch from 29:22

More LPs have started asking me how to enter Venture Capital. My first piece of advice is to go in with their eyes wide open. Great companies take time to build, and so do great funds. LPs should expect long periods without liquidity and resist any GP promising otherwise. They should also size commitments around the possibility of a complete loss. I write small checks using capital I do not need for my living expenses. Venture Capital remains extremely risky, and in my view only top-decile performance compensates for the illiquidity. Mindset-Based Investing can improve selection, but it cannot remove those basic conditions.

Conclusion: tl;dr

Conventional VC fund due diligence starts with the track record and the data room. Both remain useful, but have limits – particularly with Emerging GPs: track records are short or nonexistent, outcomes take years, and luck can make poor decisions look good.

After analyzing how top LPs select Emerging fund managers and how top Venture Capitalists make investment decisions, I developed a framework, Mindset-Based Investing, to help improve capital allocation in VC.

I evaluate the GP as an entrepreneur first, separate decision quality from outcomes, favor Investors who are trying to win, and look for resilience rather than stubbornness.

Those four rules formed the core of my due diligence on Martin Tobias’s fund, Incisive Ventures II. They gave me enough conviction to commit without opening the data room he sent me.