Follow me @samirkaji for my thoughts on the venture market, with a focus on the continued growth with the emerging manager landscape.
For emerging managers, the actual capital raise of a fund represents the most significant friction point for getting off the ground (and early on, scaling a firm). This issue has prevented many aspiring investors from starting firms, and has led to the advent of models such as the AngelList Rolling Fund product.
There are several reasons for fundraising being so difficult:
The opacity of the Limited Partner (LP) landscape. Although transparency has improved through efforts such as the #OpenLP efforts, it remains challenging for fund managers to assess which investors are genuinely active, the authenticity of LP interest, and the continuous shifting of investing mindsets due to variables external to the fund manager (because of this, GP’s regulars compare notes with one another on specific LP’s)
Reliance on family offices. From our report in late 2018, nearly 70% of capital going into Fund 1 offerings are from family offices or high net worth individuals. Active family offices are hard to find, as they rarely market their venture investing activities. Additionally, each family office operates very distinctly (unlike institutional LPs that have more predictable decision-making frameworks).
Limited Partners generally prefer to invest in proven managers, placing much more weight on access than discovery. The appetite for untested entrants is typically lukewarm at best, and managers must cast a vast net to successfully raise a fund (generally 200–500+ LPs during a Fund 1 process). This process can be time-consuming with many false positives.
The amount of competition for LP capital is high. The number of emerging managers currently in existence (or looking to form) is 1,200+ in the US and growing. Additionally, the time between established managers coming back with fund offerings is two years (or less). It’s no surprise that the average fundraise typically spans 18–24 months.
The current environment. The pandemic has halted travel, leaving pitch meetings with LP’s limited solely to video and phone conversations. While this does result in a more efficient process, there are many LP’s (particularly institutional ones) that still place high weight on meeting a partnership or individual before allocating. It’s not apparent to me if the lift from efficiency has overcome the practical challenges of not having in-person meetings.
Not surprisingly, a question that I’ve gotten a lot this year from emerging venture managers is whether they should enlist a placement agent. First, what do placement agents? Placement agents are generally broker-dealers that assist managers in all aspects of fundraising, including helping with marketing materials, developing fundraise strategy, and reaching out/following up with LPs to increase the success of the raise and truncating it. In exchange, these placement agents typically take a 2–3% fee on capital placed along with at times, a small retainer regardless of capital placed. For example, if the placement agent raises $20MM for a manager, the manager would pay between $400K-$600K, usually spread over 2–4 years (check with counsel on whether this fee is a fund or management company expense as I have seen both).
Although fund managers regularly use placement agents in traditional private equity buyout offerings, it’s relatively rare to see in VC. Medium to large venture shops typically employ an internal Investor Relations team and have installed existing LP bases, while smaller funds usually are left to their own devices to raise.
There are a couple of main reasons for this:
1) Placement agents are particular in who they take on, generally opting for larger offerings where economics are more attractive (and those that represent a smoother path for the placement agent). Historically, outside of strategic exceptions, it has not been common for established placement agents to take on sub- $ 50MM offerings.
2) In venture, the use of a placement agent is often viewed as a negative signal by LP’s (“Why does the manager need one, what’s wrong? If the manager cannot compellingly tell their story, how are they going to win deals?”). As an aside, I find that the fundraising process is a critical part of the refinement of a narrative & the building of mission-critical relationships, and thus should not ever be 100% outsourced.
However, let’s revisit whether emerging managers should use a placement agent as there are now many individuals and boutique placement agents that will take on smaller managers. While I still lean toward no for the vast majority of managers, there is a business case to give fund managers more time to tend to other firm and fund building activities such as working with portfolio companies. If you do employ a placement agent for your raise, here are important considerations:
1) The placement agent has an LP base that is orthogonal to yours. For example, if your network is solely US-based, it may be helpful to have a placement agent specializing in working with European or other offshore LPs. If you have institutional LP relationships, someone that specializes in family offices could be very helpful.
2) The placement agent has a deep understanding of the idiosyncratic nature of venture capital. I’ve seen placement agents with a hedge fund or PE placement background try and unsuccessfully place venture offerings.
3) The placement agent truly has trusted relationships with LPs. The downside of an economic model that is tied to capital placed, many LPs are naturally wary of placement agents they don’t know well, which can result in a visceral reaction that the placement agent is peddling an inferior product. Make sure you do your diligence and talk to other *similar* managers that have used that placement agent.
4) The placement agent has clear alignment toward you and your vision toward the engagement. Discuss expectations on who will do what, how the product will be marketed, and how you will work with them throughout the process.
5) The economics of the deal. While 2% on capital placed is typically the average, I have seen placement agents charge between 1–3% in emerging venture. Additionally, it’s essential to understand whether you will be charged on LPs that you both know (generally this is determined upfront through the manager identifying those LPs) and the placement agent’s fee repayment period. If the fee is too rich for you, you may want to opt for a consultant that only charges based on a retainer (but likely will be a much lighter version of the services of a traditional placement agent).