Securing Initial Capital: Considerations for Fund Managers

Obtaining funding for a new investment fund presents inherent challenges. A crucial question arises: should preferential economic terms or additional benefits be extended to a seed anchor investor who provides a substantial commitment to the fund?

These investors, often referred to as “VCs for investment management companies” or GP stake investors, function as fund platforms. Recent data from DocSend indicates that approximately half of VC firms surveyed had secured an anchor LP for their fund. The average stake taken by an anchor LP in a first-time fund was 25%. This suggests that attracting an anchor investor can be vital for establishing a firm’s credibility with other potential LPs.

However, obtaining data regarding preferential terms granted to these anchor investors proves difficult.

The Landscape of Fund Platforms

Ha Duong, investment principal at Ocean Investment, notes the prevalence of fund platforms within the hedge fund sector, where transparency is greater. In contrast, such platforms are less common in the venture capital space.

Several firms offer infrastructure support to emerging VCs, including Capria, Draper Venture Network, Oper8r, and Recast Capital. These entities may provide capital or assistance with fundraising efforts.

The private equity and hedge fund sectors exhibit a more developed ecosystem in this regard. Examples include Archean Capital Partners, Gatewood Capital Partners, Lafayette Square, Nesvold Capital Partners, and Reservoir Capital Group. Family offices also participate in these investments, as do some VCs like LuneX.com, which partners with Golden Gate Ventures, a Southeast Asia-based VC firm.

Advantages of a GP Stake Investor

A GP stake investor offers several key benefits:

• Significant Initial Capital: This upfront investment can substantially accelerate the fundraising timeline, particularly benefiting founders lacking substantial personal wealth.
• Enhanced Credibility: The investor’s reputation lends weight to the fund, signaling thorough due diligence to other potential LPs.
• Operational Support: Assistance can be provided in areas such as business development, marketing, risk management, and governance.
• LP Access: Access to LPs requiring substantial assets under management (AUM) can be facilitated.
• Back-Office Functions: In some instances, administrative support may be provided.

Potential Disadvantages to Consider

Working with a GP stake investor also carries potential drawbacks:

• Reduced Initial Revenue: The investor typically receives a share of the management company’s revenue. Research on hedge fund seeders suggests this share ranges from 15%-25%. Additionally, discounted management and carry fees on contributed AUM may apply (1%-1.5% management fee, 10%-15% carry). Historically, seeders expected 1% of revenues per $1 million of seed capital, though this model may not apply to larger transactions. This revenue share typically extends for five to ten years.
• Limited Long-Term Upside: Seeders often acquire 1%-10% of the management company for their capital infusion.
• Restricted Autonomy: A significant lead investor may exert greater influence over fund operations and investment decisions than a typical LP.
• Complexity of Disentanglement: Separating from the investor can be challenging if strategic considerations change.
• Increased Risk: Reliance on a single primary investor creates a point of failure. A diversified shareholder base is generally more resilient.
• LP Concerns: Other potential LPs may express reservations about the relationship, as the anchor’s interests could influence fund strategy.

Emily Campbell, founder of Campbell Firm PLLC, emphasizes the importance of carefully examining the dynamics between the anchor investor and the management team to mitigate potential pressures.

Thorough scenario planning, including potential shifts in the anchor’s goals or changes within the management team, is crucial for a successful partnership.

Potential Concessions for Stake Investors

Here are some potential benefits to offer a stake investor during negotiations:

• Financial Incentives: Consider a reduced management fee and/or a stake in the GP’s economics.
• Transparency: Provide in-depth insight into decision-making and firm management processes.
• Due Diligence Support: Offer to conduct due diligence and prepare investment memos on companies aligned with the LP’s mandate.
• Marketing Collaboration: Explore co-sponsorship and speaking opportunities at LP conferences, as well as joint event organization.
• Joint Investment Commitment: Express a commitment to raising capital for joint SPVs and fund anchoring initiatives.

Industry Perspectives

Public discussion of this topic remains limited. Lo Toney, founding managing partner of Plexo Capital, has publicly addressed the possibility of selling a stake in your GP.

Ultimately, the decision may hinge on timing.

Victor Park, CEO of Capital Introductions, advises that if an opportunity arises to secure seed capital on favorable terms from an anchor investor, it should be pursued. However, requests for a percentage of total fees across all future vehicles should be met with negotiation, focusing on specific performance criteria for the anchor investor, such as providing references, granting press rights, and facilitating introductions to their client base.

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 provided me with legal counsel on certain matters.