Raising capital for a new fund is always hard. Should you give preferential economics or other benefits to a seed anchor investor, who makes a material commitment to the fund?
These “VCs for investment management companies” are also known as GP Stake investors or fund platforms. According to DocSend, “About half the VC firms in our survey had an anchor LP for their fund, and the average percentage that an anchor LP took in a first-time fund was 25%. The prevalence of anchor LPs among both early-stage and more established firms in our data suggests that securing an anchor investor can be crucial for signaling a firm’s credibility to other potential LPs.” However, data about whether those anchors received preferential terms is very hard to obtain.
Ha Duong, Investment Principal, Ocean Investment family office, said to me, “In the hedge fund world, fund platforms are common and therefore more transparent. In venture, I haven’t seen many fund platforms.” A number of firms provide infrastructure for emerging VCs, e.g., Coolwater Capital, Capria, Draper Venture Network, and Recast Capital. All provide assistance in raising capital, and some (e.g., Coolwater Capital) provide capital directly. However, this ecosystem is much more built out in the private equity and hedge fund space, e.g., Archean Capital, Capital Z, Fund Launch Partners, Gatewood Capital Partners, Lafayette Square, Nesvold Capital Partners, Petershill Partners, Stable Capital, Tiger, Wafra, and Reservoir Capital Group. Certain family offices also make these investments on an ad-hoc basis. As do some VCs: LuneX.com says, “LuneX Ventures is a dedicated Blockchain and CryptoCurrency fund in partnership with Golden Gate Ventures, a well established South East Asia based VC.”
I’ve worked on several transactions of this type, on both sides of the table. A GP stake investor can bring some significant advantages:
- Meaningful upfront initial capital, usually greatly shortening the lengthy fundraising process. This can be particularly helpful for founders who do not come from a wealthy background, who may not be able to afford going without income for an 18 month fundraising period.
- Credibility/signaling (proportionate to the stake investor’s credibility). Everyone else will assume the GP stake investor did extensive due diligence.
- Assistance in business development, marketing, risk management and governance. Trilliam Jeong, CEO, WealthBlock.ai, observed, “This is what most of the anchors claim to bring. But in reality, few can deliver on that claim.”
- Ability to access LPs who require a meaningful AUM before they’ll consider you.
- Back office, in some cases.
Victor Park, CEO, CapitalIntroductions.com, said, “The best time to raise capital is “when” you can. If given an opportunity to take seed capital on a discounted fee basis from an anchor investor, I’d always do that deal on a vehicle-specific basis. If the seed and/or anchor investor asks for a percentage of total fees for any future investors across other vehicles, I’d try to negotiate specific performance criteria required of that anchor investor: serving as a reference; full press rights on the use of their name; and if possible even introductions to their end clients.” Jeong recommended, “Treat them as a co-manager who needs to earn their fees with their performance. A good framework is to separate their roles as pure money investor and co-manager. Putting dollar value on each role independently can keep you disciplined and rational in negotiation.”
There can also be meaningful disadvantages to working with a GP stake investor:
- Typically lower initial revenue, as the GP Stake investor gets a share of the management company’s revenue.
- Possibly less long-term upside.
- Fewer degrees of freedom. A strong lead investor may expect to have more of a say than a typical LP in how the fund is operated and its investment choices.
- Potential difficulty in disentangling if it makes strategic sense to do so.
- Greater risk. You have a primary point of failure, and a really dominant anchor means you have a boss, which most founders are trying to avoid. A diversified shareholder base is long-term healthier.
- Other potential LPs may have concern about the relationship. Marco Cesare Solinas, Analyst, Blue Future Partners, observes that the anchor may affect incentive mechanics, decision making, and focus of the fund, which may be weighted towards the anchor´s particular interest.
The hedge fund world has a much more developed seeding ecosystem, so I’m using that asset class as a source of benchmark data. A hedge fund stake investor might get charged discounted management/carry fees on the AUM they contribute, e.g., 1-1.5% management fee, 10-15% carry, according to Troutman Pepper. From CAIA: “Before 2008, a widely accepted rule of thumb was for a [hedge] seeder to expect 1% of revenues for each $1 million of seed capital. Though this rule breaks down quickly as seed transactions reach and exceed $50 million, at smaller transaction sizes, the rule still seems to hold. In some instances, terms may be even more favorable to the seeder than the 1% per million rule of thumb.” This revenue share will normally extend for 5-10 years. However, small AUM funds may not do a revenue-share, since they don’t have much cushion after paying modest salaries and setting up basic infrastructure. Other sources indicate a typical share of the management company’s revenue is 15-25%, according to research on hedge fund seeders from Dechert, Scaramucci, and PIonline.
Some emerging managers seek a working capital infusion. For this, hedge fund seeders will typically get an equity stake of 1-10% of the management company (either in incentive fee revenues only or in both management and incentive fee revenues), according to Troutman Pepper.
Emily Campbell, Founder and Managing Member of the Campbell Firm PLLC, a lawyer, said, “If the anchor is closely tied to a particular person or persons on the management team, the dynamics have to be examined closely to minimize the risk that there will be extra pressure placed on those persons with a relationship with the anchor or the risk that extra pressure will be placed on the persons not affiliated with the anchor. Doing some ‘what ifs’, including what if the anchor’s goals change or what if the persons with whom the anchor is affiliated want to move on to other opportunities, will be important so that the team can go into the venture with their eyes wide open.”
Here’s what I suggest sharing with the stake investor as the possible “gives” in your sales pitch:
- Economic benefits: typically lower carry, possibly lower management fee and/or a stake in the GP’s economics
- Deep transparency into decision-making and firm management processes.
- Complimentary and complementary due diligence. LP can ask the fund to complete due diligence and prepare investment memo on any company which fits our mandate.
- Cross-marketing of LPs
- Co-sponsorship and speaking slots at annual LP conference.
- Jointly organizing events.
- Best-efforts commitment to raise capital for joint SPVs & joint fund anchoring.
- For a list of other negotiating points, see How to join a VC firm as a Partner
Eric Woo, co-founder, RevereVC, said, “As the gates of access to VC come down and the influx of more diverse/permanent pools of capital enter, GP staking and buying into the management company of an upstart fund will become less a one-off transaction and more of a specialized “play” in VC. Expect to see more players, standardized terms, and less stigma associated with a GP selling a GP stake to get into business. “
Very few people publicly discuss this issue. One exception is Lo Toney, Founding Managing Partner of Plexo Capital, who has discussed publicly selling a stake in your GP. Some other resources from the hedge fund world:
- The ABCs of Private Equity GP Stakes
- Pitchbook: What is GP stakes investing?
- CAIA: Hedge Fund Seeding: A Compelling Alternative
- Dechert: Hedge Funds Nuts & Bolts: Seed Investors
- Schulte Roth Partners Discuss Hedge Fund Seeding
- Irwin Latner, a member of Hedge Connection’s Boardroom and a Partner at Pepper Hamilton LLP: Trends for Early-Stage Investing in Emerging Managers
- GP Stakes in Private Equity (academic empirical analysis)
Further reading:
- 15 Steps to Fundraising for Your New Venture Capital or Private Equity Fund
- Fundraising hacks for VC and private equity funds
- Limited partner checklist for evaluating funds
- Syllabus for how to launch, manage, and invest a VC fund
- VCs eating their own dog food: Using technology and analytics to make better investments in private companies
Thanks to Dave McClure for feedback. Disclosures: Blue Future Partners is a member of the LP Advisory Board of ff Venture Capital, where I was formerly a Partner. Emily Campbell has advised me on some legal matters.
Previously published in Techcrunch.
