Ask A VC: Rick Smith, Co-founder and Managing Director at CrossCut Ventures

CrossCut Ventures is an early-stage venture capital fund based in Los Angeles investing in consumer Internet, enterprise software, and gaming. CrossCut recently closed a $75M round for Fund III, which made them one of the largest seed funds in LA. Rick Smith graduated from Harvard Law School with a JD degree. With 20+ years of private equity experience, he founded the $750 million venture capital arm of SunAmerica in 1997, realizing 11 successful exits. As a partner in Palomar Ventures, he oversaw $500 million across three venture funds.

Pocket Sun: Tell us about the recent close! It was a great success.

Rick Smith: We were oversubscribed for the Fund III. We planned for $50M, but ended up with $75M. The first close happened in November 2014, and the final close happened recently in June 2015. CrossCut had four family officers that invested in the first two funds, but this time institutional investors also got on board. Fundraising is always difficult. What helped with fundraising this time was recent liquidity events that proved CrossCut’s portfolio performance and ability to exit (which is getting more difficult these days). More companies choose to stay private when their revenue and amount of funds raised are insanely high. This is because more capital is flooding into the private markets now and the reason to go IPO has become not so obvious. There are more liquidity opportunities compared to 10 years ago, however. People are willing to buy-in and put capital into the market. Even hedge funds and mutual funds are entering later rounds of venture capital now.

Pocket: Did your experience in private equity prepare you for venture capital?

Rick: Yes, for a variety of reasons. Private equity is focused on companies making money, and buyers only look for profitable companies. It’s a good base to know that the company eventually needs to make money! Ultimately, there should be a way to get to profitability, and knowing the buy out side is helpful to take portfolio companies to exits. The financial disciplines are also similar, and taught me to look at companies very carefully. The profitability timeframe looks different for every company.

While it is true that venture capital funds hyper-growth and acquisition of a large base of users, founders still have to know how to make money in the long run.

Pocket: Let’s talk about… the bubble!

Rick: There are some lofty valuations in the market, everyone knows that. The key is to know how you make valuation judgments. The “bubble” has not filtered down to seed and early stage yet, and we are seeing relatively reasonable valuations. Hopefully we are still in a good circle where risk and reward are more aligned! Our portfolio companies actually benefited from higher evaluations in Series A.

Pocket: What do you think of the ecosystem in Los Angeles vs. Silicon Valley?

Rick: CrossCut Ventures has mostly invested in Southern California, as well as 20–25 companies outside the region. On the quantitative side, LA is more realistic and valuations are lower. This region is particularly good at E-commerce, AdTech, storytelling, entertainment, fashion and social media. On the qualitative side, LA is more cooperative, which brings many advantages to the ecosystem. VC firms actually help each other and co-invest in deals. The mindset is that we are all in this together. If one firm does well, others will do well, too. Currently, LA is still an underserved and undercapitalized, but this perspective will benefit LA further down the road.

Pocket: What do you think of the relationships between VCs and entrepreneurs? How do you help your portfolio companies?

Rick: Well, we help with the management team, sit on their board, and we are the observers of their businesses. Sometimes we can help with the business development side and bring in large potential clients. We also help companies raise the next round, and pick the right people to go to for the next round. We like entrepreneurs that are smart, passionate, driven, and relatively good communicators. VCs want to see if you can manage the company, convince others to work with you, and have great people behind you. We see great ideas every day. But it’s about the team and the leader.

Pocket: How did you build the CrossCut Ventures brand? Do you put marketing behind it?

Rick: We build our brand by having a good portfolio. Our job is to find good companies, not to market ourselves. We like giving back to the community (through speaking opportunities). It’s less about marketing, but more about letting people know what we think and what we fund.

Pocket: What happens to VC firms that do not perform well? How are the relationships between CrossCut and your investors?

Rick: Funds continue on for a period of time. It becomes clear at some point that they can’t raise any more. They do have to perform. We do full reports to our investors (LPs) on a regular basis, while keeping constant informal communications to update the investment status. CrossCut also hosts yearly meetings for our investors, and CEOs of portfolio companies report their growth performance. Investors do have high expectations of returns, but they also know that it takes time. It’s more about sticking to the investment thesis and monitoring the performance over time.

Pocket: What’s been your favorite company to work as an investor for? Do you think portfolio companies’ success depend on the investor? If so, how much?

Rick: We don’t play favorites as VCs, but any company that returns a multiple of our invested capital to our investors secures a special place in our corporate heart. It is certainly the case that a VC that is active in guiding a company, and is making introductions to prospective employees, customers, business development partners, investors or acquirers can have an impact on a company’s trajectory, but nearly all the success eventually is driven by the team.

Pocket: Currently only 4% of VCs are women. Why do you think that is? What’s your experience working with female VCs and founders? Do you think the industry benefit from having more women investors?

Rick: The substantial underweighting of women in VC is a direct reflection of the underweighting of women in places where VCs tend to come from: startup companies, finance and engineering. We had an event last week where we brought together 40 or so female entrepreneurs in LA and several investors, in order to raise the visibility of women founders and allow them to meet investors that they might not otherwise have had a good chance to meet.

Pocket: If you could predict what venture capital will look like in 10 years, what will have changed?

Rick: There may be less crowdsourcing of funding. The next economic downturn will wash out many of those investors.

Interviewed on July 2, 2015.