sumo david goliath

Size matters. But to dispel a commonly repeated myth, bigger isn’t always better – in terms of VC fund size, that is. Many mega-firms have learned as much in recent years, pulling back from billion dollar fund sizes in search of more manageable multi-hundred million dollar sums that can be put to use more effectively.

But at the very opposite end of the spectrum are micro-VCs, which, whether by choice or lack of access to additional capital, have to make due with far, far less. These sub-$50 million dollar funds often find it difficult to support multiple investment partners on the meager fees they generate, and can be handicapped in their ability to write larger checks or double down once they do make a winning early stage bet.

Below is the story of one firm that didn’t just beat these odds but stomped all over them and left them crying for their mothers.

Crosscut Ventures raised its first fund in 2008. Those of you who haven’t blocked it from your memories will recall was the one of darkest periods for venture capital ever. With the global economy in the tanks, and many institutional investors barely recovered from the dot bomb of the early 2000s, venture money was beyond hard to come by. Thus, Crosscut founding partners, Rick Smith, Brian Garrett, and Brett Brewer were forced to go to wealthy individuals rather than institutions in search of backing, any backing.

They managed to scrape together just $5.1 million. It’s a figure that would make for a respectable angel portfolio, but which would make it difficult to lead venture-stage rounds and to make enough bets to assemble a meaningful portfolio. In other words, it was an ominous start to their new firm.

The thesis put forth by the Crosscut partners was twofold. First, they believed that Los Angeles (and Southern California at large) was poised for a technology renaissance, and that with a dearth of capital in the market they would be positioned to make early bets in many of the next generation of winners. Recent history seems to have proved them prescient. Second, they believed that their combined operating and investment experience would give them a better chance than most at picking the winners from the losers.

Smith, a career financier with a Harvard JD, and Garrett, a Stanford MBA and former business development executive, worked together at Palomar Ventures in the early oughts where they managed several multi-hundred million dollar VC funds. Brewer is a career entrepreneur, who most notably founded MySpace and Alena.com parent Intermix Media – which sold to NewsCorp for $680 million in 2005 – and more recently has been President and Chairman of AdKnowledge and CEO of SENSA.

But throw all the accolades you want at this trio, none of it changes the size of their diminutive $5.1 million war chest. From 2008 through 2011, Crosscut made just 18 investments. This number was dictated by the size of bets they wanted to make and the need to set aside a portion of the fund for follow-on investments. But, like a sniper down to his last few bullets, Crosscut made their fair share of shots count.

Out of the 18 deals, the company has seen three exits to date, and has already returned the fund 3.4 times. The first, Circle Street, was acquired by Valassis for an undisclosed sum in 2012. The second exit was the firm’s investment in Dermstore, an online beauty retailer founded by Brewer’s former Intermix partners Adam Goldenberg and Don Ressler. The company was acquired by Target in August of this year, for a sum reportedly between $125 to $150 million.

But the biggest winner, however, was a deal that might go down as the flip of the century. Crosscut was one of the first investors in Brian Lee’s subscription shoe rocketship ShoeDazzle, getting in at a valuation “well south of $10 million,” according to Garrett. But, less than two years later, when smart money from Silicon Valley reportedly priced the company at a staggering $200 million-plus, Crosscut cashed out the majority of its stake. While Smith declined to reveal the details such as the size and valuation of the initial investment, he says that this one transaction more than returned the fund.

But it was the next move that showed Crosscut was more good than lucky. As investors in ShoeDazzle, they were privy to the internal operating metrics of the company and realized that the high-flying shoe etailer wasn’t on as sound of footing as it appeared from the outside. So, when presented with the opportunity to invest in cross-town rival JustFab – after exiting ShoeDazzle – which again is run by Brewer’s old pals Goldenberg and Ressler, who are considered by many to be among the best ecommerce operators in the business, they jumped at the opportunity.

Today, JustFab is looking like the runaway winner in its category, scooping up ShoeDazzle for pennies on its one-time nine-figure valuation in September and racing toward $400 million in projected 2014 revenue – the acquisition even netted Crosscut a few more more JustFab shares in exchange for its remaining ShoeDazzle holdings.

So in addition to the value already realized from the three exits to date, reportedly amounting to a 3.4X return on the diminutive $5.1 million fund, Crosscut I stands to eventually cash in on JustFab as well as another six “likely winners” according to Smith’s admittedly biased assessment. He qualifies this prediction by saying that each is exhibiting high growth, multiple millions in revenue, and has booked valuation increases in subsequent funding rounds – none of which guarantees a successful exit.

Within the same fund are seemingly promising investments in SHIFT, which Crosscut claims is generating 400 percent year-over-year growth, Verve Mobile, which is doing a not too shabby with its own 300 percent year-over-year growth, GumGum, Ipsy, DocStoc, and Pulpo Media.

So, if Smith’s predictions prove accurate, Crosscut one will have generated a return on 10 out of 18 investments, a 0.555 batting average that would make it the venture capital equivalent of David “Big Papi” Ortiz this October. Of the remaining eight deals, there have been three outright zeroes and five that remain too early to tell, Smith says. But when asked to venture a guess, Smith predicts the fund to eventually close well north of a four-times return.

Crosscut has since followed up by raising a $16 million second fund in 2012, a haul that again came exclusively from individual investors, and is about to enter the market to raise a third fund with a number in the $50 million range in mind.

The team at Crosscut has expanded in concert with its checkbook, adding two Venture Partners in the last 18 months. The first was Adam Goldenberg – it’s the least they could do after the hefty returns he generated with Dermstore and presumably JustFab. The second is Clinton Foy, the former COO, General Counsel, and head of business development for video game publishing giant Square Enix.

A few things have worked in Crosscut’s favor. First, the company picked the right horse to back in Intelligent Beauty, parent company to JustFab, Dermstore, and SENSA. This one ecommerce incubator will likely generate the bulk of the returns in Crosscut I.

Second, both Garrett and Brewer have remained full time operators, both in the ecommerce sector — a sector on which many of the firms bets have focused — while managing the fund at the same time. Many would view that as a distraction, rather than an advantage, but the Crosscut partners argue that it’s allowed them to keep their fingers on the pulse of the industry and to better relate to the founders that they back. They may be on to something, but tellingly, both expect to focus more on Crosscut than on their operational roles once Fund III is in the bank.

It’s still far too early to tell whether Crosscut has maintained its torrid pace with its second fund or what the market appetite will be when the partners look to ratchet up the size of their upcoming third fundraise. But it’s hard to argue with the results of Crosscut I, which is likely one of the best 2008 vintage funds in the country.

According to Cambridge Associates, the mean IRR as of June 2013 for the 58 funds formed that year was 13.75 percent. While we don’t have enough data on Crosscut I to complete a precise IRR calculation, a back of the envelope analysis where the firm hypothetically distributes a 3.4X return (roughly $17 million) in 2012 and another 0.6X return this year bringing the total to 4X over five years and the IRR comes in at around 40 percent, trouncing the national average.

As they say, with mo’ money comes mo’ problems. But if I were one of Crosscut’s partners or LPs, the thing that would keep me up at night is the question, what if they had more money to work with five years ago?

There are no do overs in venture capital, but Crosscut is about to get the next closest thing as makes the jump into the next tier of venture firms.

[Image via TeaLeaf]

  1. We are a seed-stage venture capital firm that uses our expertise and network to help passionate entrepreneurs build great companies.

    We are focused on investing in and growing capital-efficient, Internet-enabled companies in the underserved and growing Southern California market.

    You will not find a VC firm in the country with deeper operating expertise AND a track record for managing institutional money.

    1. Rick Smith
      Founder