VC firm Neo looks to up the ante with $235M across two new funds

Neo, a six-year-old, Bay Area–based outfit founded by renowned serial entrepreneur and investor Ali Partovi, is announcing that it has garnered $235 million in capital commitments across two new funds. According to Partovi, $180 million will be invested in seed deals and via accelerator programs spun up by Neo; the rest, $55 million, will be funneled into later-stage investments.

The capital brings Neo's assets under management to more than $600 million and could more or less be viewed as an endorsement of what Neo has assembled, which is traditional in some ways -- and also very far from it.

On the one hand, Neo invests in startups on similar terms as traditional VCs, including via a three-month-long accelerator program that accepts 20 technical teams each spring. But Neo also invests heavily in mentoring that extends well beyond the founders to whom it writes checks. Sometimes it has meant bringing engineering students into the fold who wind up at Big Tech companies; at other times, it has meant pointing them toward other startups getting off the ground.

All of these "Neo Scholars," 30 of whom are selected each year, will help Neo over time as much as it helps them, is the thinking. Some might eventually launch startups and Neo wants to be their first phone call. Others may help tighten Neo's relationship with other companies. Partovi says, for example, that Neo made "late-stage investments in companies like Ramp, Watershed, and MosaicML after helping them recruit Neo Scholars that have become among their highest-performing engineers."

We talked about Neo's latest funds last week with Partovi, who says more than $100 million, or 45% of Neo's capital deployed to date, has been committed to startups led by women and underrepresented CEOs. He also told us that Neo has 51% gross IRR (used to estimate the profitability of investments) across its funds. Though investors are typically focused on net IRR, meaning after fees and other costs, Neo's newest backers -- including Eric Schmidt, Henry Kravis, Joe Gebbia, Max Levchin, and Sheryl Sandberg -- seem happy enough. Indeed, they are so numerous that Partovi offered to create a visual collage for this editor.

More from our exchange follows:

TC: You say funds have earned 51% IRR since inception, pointing to investments in Ethena, Forethought, Kalshi, Kepler, Pavilion, and Vanta. Have any raised follow-on funding in 2023? Clearly, a lot of companies are seeing their valuations reset right now.

AP: Among those six companies, almost all raised follow-on funding in the second half of 2022, after the stock market reset in May 2022, and none of them needed to raise more in 2023. The 51% IRR figure is based on more than a hundred investments across two portfolios. The majority of the portfolio has raised follow-on funding in the last 12 months. In some cases, we've also proactively marked down valuations even if the company didn't have a down round, to keep in sync with the market.

Neo is very young, of course. Have any of its portfolio companies already been sold or gone public?

None yet. Thankfully, Neo is still very young. In this market, I’m really grateful to be working with earlier-stage companies.

You have long focused on CS students because these are often the people who wind up building startups or making them work. Are you worried -- or should CS students be worried -- that this is changing because of generative AI?

Computer science is about more than coding. What do Jeff Bezos, Steve Jobs, Mark Zuckerberg, Larry Page, Sergei Brin, Bill Gates, Reed Hastings, and Larry Ellison all have in common? The CEOs of the world’s most valuable companies all studied computer science.

At its core, computer science isn’t just about coding: It teaches you how to think. I'm not worried about AI replacing thinking. Also, CS folks are best positioned to adapt to the changing world, and I’m excited to work with a new generation of leaders.

What do you say to someone who still wonders if software engineers will be rendered obsolete?

For 20 years, the software world has seen new technology automating menial tasks, and this has only made engineers more productive and more empowered. A tiny team can now do so much with so little.

Have you changed your coding interviews or will you because of generative AI?

Evaluating technical talent is just one part of how we evaluate a team for investment. We've been modifying our technical assessment strategy and live interviews every year. Since 2021, instead of relying only on coding interviews, we've let each candidate choose how they want to be interviewed -- options include a "debugging task" or "code walkthrough."

Are there new skills for which you are looking -- again, tied to the massive changes afoot?

We evaluate teams for a wide range of attributes, from emotional intelligence and leadership skills to technical expertise, and different team members may have different strengths. Whether for coding or sales, knowing how to use AI to be more productive is a major competitive advantage.

You were long an angel investor. What about running institutional venture funds has surprised you? What are you doing differently with this new fund as a result of your learnings to date?

I’ve been a founder multiple times. I identify with founders. I have empathy for founders. Yet, as soon as you switch from being an individual founder-angel to running an institutional fund, you need to re-earn trust, because other founders are taught to be wary and less vulnerable with VCs. That’s why we’ve intentionally assembled our investing team and mentors to include a lot of founders — so that empathy and trust are there from the beginning. It’s also one reason why I regularly tweet about my own business failures.

How much of your new early-stage fund will be invested via your accelerator versus into seed-stage companies that don't pass through your accelerator program? What have been these percentages, respectively, in previous funds?

In the last fund, only about 12% to 15% of our early-stage capital backed accelerator startups, because we started the accelerator late in the fund's life. Going forward, we expect our early-stage fund to move closer to an equal split between accelerator companies and regular seed/pre-seed investing.

How big a stake in each company will you buy via your accelerator, and how much money should companies expect to receive in return? When we talked a little more than a year ago, Neo was offering up to $625,000 for a maximum of 5% of each startup, with a $20 million “floor” valuation. Neo was also giving every founder a small share in every other startup in the batch to motivate them to help one another.

Compared to last year, the only change is that the "floor" valuation is adjusted so that our maximum stake in each company will be 7.5%. Due to the uncapped nature of our deal, depending on the next round's valuation, our stake might be lower, unless we put in additional money at the next round's valuation. We try to be as transparent as possible, so you can find all of this in detail on our website, even including the legal docs.

Will Neo invest only in its own portfolio companies with its new growth fund?

The Neo Opportunities fund is available for exceptional investment opportunities that we earn by referring exceptional engineering talent to later-stage startups. We've been doing this since 2018, and it’s given us unprecedented access to invest in some amazing companies. For example, we made late-stage investments in companies like Ramp, Watershed, and MosaicML after helping them recruit Neo Scholars [who have] become among their highest-performing engineers. In the past, we did investments like this from the same main fund, whereas now we'll be doing them from a separate fund. The Opportunities fund will also invest in later-stage rounds of our own prior investments.

You have a lot of notable angel investors investing in your funds. Can you share the names of any of your institutional investors?

Cendana Capital, Horsley Bridge, Sequoia Capital, and others.

How much of these new funds came from you directly?

About 2%. As our funds have grown from $80 million to $150 million to now, I've put more and more of my own cash into each one.

What percentage of Neo Scholars have launched their own companies? Are you starting to see them leave their big companies after receiving some training to start their own thing? Do you think we will see less or more or this as the economy plods along?

I'd estimate that 20% of Neo Scholars have tried starting a company, either straight out of college or a few years later. We've now funded about 23 companies started by Neo Scholars, and that count is growing because many of them are now 3 to 5 years out of school and ready to do something new.

We also see far more deals because they refer their friends to us. Our new fund has already funded about 20 startups built by recent grads who are less than 3 years out of college -- a quarter of these teams included Neo Scholars, and three quarters were friends of Neo Scholars.

I think we'll see way more young people leaving their jobs to join or start new companies -- both because it's easier than ever with AI, and because big companies have lost their one advantage, which was stability. Big companies offer less stability today than they used to, whereas early-stage startups are relatively sheltered from the macro storm. A well-funded early-stage startup is among the stablest places to work or invest today.