VC firm Neo wants to raise the bar with $235 million in two new funds

Neo, a six-year-old Bay Area company founded by noted serial entrepreneur and investor Ali Partovi, announces it has raised $235 million in capital commitments in two new funds. According to Partovi, $180 million will be invested in seed deals and through accelerator programs created by Neo; the remainder, $55 million, will be funneled into later stage investments.

The capital brings Neo’s assets under management to over $600 million and can be seen more or less as an endorsement of what Neo has accumulated, which is traditional in some ways – and far from it either.

On the one hand, Neo invests in startups on similar terms to traditional VCs, including through a three-month accelerator program that accepts 20 tech teams each spring. But Neo also invests heavily in mentorship that extends far beyond the founders to whom it writes checks. Sometimes it meant bringing in engineering students who ended up at Big Tech companies; at other times it meant pointing them to other start-ups that were taking off.

All of these “Neo Scholars”, 30 of whom are selected each year, will help Neo over time as much as they do, it is thought. Some may end up launching startups and Neo wants to be their first call. Others can help strengthen Neo’s relationship with other companies. For example, Partovi says Neo “invested late-stage in companies like Ramp, Watershed, and MosaicML after helping them recruit Neo Scholars who have gone on to become their top-performing engineers.”

We spoke last week about Neo’s latest funds with Partovi, who says more than $100 million, or 45% of Neo’s capital deployed to date, has been committed to women-led startups and underrepresented CEOs. He also told us that Neo has a gross IRR of 51% (used to estimate investment profitability) across all of his funds. While investors are typically focused on net IRR, i.e. after fees and other costs, Neo’s newest lenders – including Eric Schmidt, Henry Kravis, Joe Gebbia, Max Levchin and Sheryl Sandberg – seem happy enough. There are so many of them that Partovi offered to make a visual collage for this editor.

More of our exchange follows:

TC: You say funds have earned 51% IRR since inception, indicating investments in Ethena, Forethought, Kalshi, Kepler, Pavilion, and Vanta. Did you raise follow-up financing in 2023? Clearly, many companies are currently seeing their valuations reset.

AP: Of those six companies, almost all raised follow-on funding in the second half of 2022, following the stock market reset in May 2022, and none needed to raise more in 2023. The 51% IRR figure is based on more than a hundred investments across two portfolios. Most of the portfolio has raised follow-on funding in the last 12 months. In some cases, we’ve also proactively lowered valuations, even when the company didn’t have a downround, to stay in sync with the market.

Neo is of course very young. Have portfolio companies already been sold or floated?

None yet. Fortunately, Neo is still very young. In this market, I am very grateful to be working with early stage companies.

You’ve long focused on computer science students because they are often the people who build or run startups. Do you worry – or should computer science students worry – 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 have in common? The CEOs of the world’s most valuable companies have all studied computer science.

At its core, computer science isn’t just about coding: it teaches you to think. I’m not worried about AI replacing thinking. In addition, CS people are best positioned to adapt to the changing world, and I am excited to be working with a new generation of leaders.

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

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

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

Evaluating technical talent is only part of how we assess a team for investment. We have adjusted our technical review strategy and live interviews every year. As of 2021, we don’t rely solely on coding interviews, but let each candidate choose how they want to be interviewed – options include a ‘debug task’ or ‘code walkthrough’.

Are there any new skills you’re looking for – again, coupled with the massive changes coming up?

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

You were an angel investor for a long time. What surprised you about running institutional venture capital funds? What will you do differently with this new fund as a result of your lessons so far?

I have been a founder several times. I identify with founders. I have empathy for founders. But once you move from being an individual founder angel to running an institutional fund, you need to gain confidence again as other founders are taught to be wary and less vulnerable with VCs. That’s why we deliberately built our investment team and mentors with many founders so that there is empathy and trust from the start. It’s also one of the reasons why I regularly tweet about my own company failures.

How much of your new seed capital is invested through your accelerator versus in seed stage companies that do not go through your accelerator program? What were these percentages respectively in previous funds?

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

How large a stake in each company do you buy through your accelerator and how much money can companies expect to receive in return? When we talked a little over a year ago, Neo was offering up to $625,000 for up to 5% of each startup, with a “floor” valuation of $20 million. Neo also gave each founder a small stake in every other startup in the batch to motivate them to help each other.

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

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 tech talent to later-stage startups. We’ve been doing this since 2018 and it’s given us unprecedented access to invest in some great companies. For example, we made late-stage investments in companies like Ramp, Watershed, and MosaicML after helping them recruit Neo Scholars [who have] are among their top-performing engineers. We used to make these kinds of investments from the same main fund, now we do that from a separate fund. The Opportunities fund will also invest in later rounds of our own previous investments.

You have many 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 directly from you?

About 2%. As our funds have grown from $80 million to $150 million to date, I’ve been putting more and more of my own money into each of them.

What percentage of Neo Scholars have started their own business? Are you starting to see them leave their big companies after getting some training to start their own thing? Do you think we will see less or more as the economy progresses?

I estimate that 20% of Neo scholars have tried to start a business right out of college or a few years later. We have now funded about 23 companies founded by Neo Scholars, and that number is growing as many of them are now 3 to 5 years out of school and ready to do something new.

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

I think we will see a lot more young people leave their jobs to join or start new businesses – both because it’s easier than ever with AI, and because big companies have lost their one advantage, which is stability. Large companies today offer less stability than they used to, while early-stage startups are relatively sheltered from the macro storm. A well-funded early-stage startup is one of the most stable places to work or invest today.

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