Emerging Managers: A New Deal Flow Source for VCs

The Rise of Emerging Venture Managers and Industry Consolidation

Nasir Qadree, a Washington-based investor who recently secured $62.1 million for his inaugural venture fund, shared that as fundraising progressed, he received offers from established firms seeking to integrate new talent.

Attracting Interest from Established Firms

While Qadree chose to remain independent, he isn't an isolated case. The integration of emerging managers into established firms is increasingly recognized as a strategy for maintaining power within the venture capital landscape.

For instance, Arianna Simpson, a crypto investor and founder of her own hedge fund, was recruited by Andreessen Horowitz as a deal partner last year.

From Intelligence to Investing

Andy Chen, formerly a weapons analyst for the CIA and with over seven years at Kleiner Perkins, was in the process of launching his own fund in 2018 when Coatue, a prominent hedge fund, extended an offer.

He now spearheads the firm’s early-stage investment initiatives.

The Appeal and Potential Challenges

The allure of these established firms, with their substantial funds and considerable influence, is understandable. However, as older firms broaden their search for new talent, they may encounter challenges; the most skilled managers may be unavailable, particularly in the current dynamic market.

Factors Driving the Growth of New Funds

A Confluence of Opportunities

Numerous factors are contributing to the surge in fund creation, including the abundance of capital seeking investment in startups, the accessibility of tools like AngelList’s Rolling Funds, and revisions to U.S. crowdfunding regulations.

Capitalizing on Industry Blind Spots

Emerging managers are also proving adept at identifying and exploiting gaps within the venture industry. One such area is the considerable wealth held by more experienced VCs.

While experience is valuable, there's a distinct advantage to up-and-coming investors who are still building their reputations, avoiding overcommitment to numerous boards, and aligning their success directly with their founders.

Addressing Overlooked Trends

Established firms have historically overlooked certain trends. Many regret their initial hesitation regarding cryptocurrency, and have for too long underestimated the growing economic influence of women – a trend that new managers are actively highlighting to their investors.

The Importance of Diversity

Furthermore, a historical resistance to racial diversification has created opportunities for investors of color, who are keenly aware of shifting demographics.

Census projections indicate that white Americans will become a minority within the U.S. population in the next two decades, signifying that today’s minority groups are driving the nation’s economic expansion.

Independence vs. Acquisition

A Shifting Landscape

The disruption caused by new managers is generally viewed as positive. However, a key question arises: can these managers maintain their independence? The answer remains uncertain.

Like the startups they invest in, many of these new managers currently operate in the shadow of established firms.

This arrangement appears mutually beneficial, as collaboration is inherent in the venture capital industry, and maintaining positive relationships with larger firms is advantageous when introducing promising companies.

Limited Partner Investments

To foster harmonious relationships and maintain deal flow, a growing number of venture firms are acting as limited partners, investing capital in new managers.

Foundry Group pioneered this approach five years ago, allocating 25% of a new fund to smaller venture funds. This practice is now widespread.

For example, Jake Paul’s influencer-focused fund is backed by Marc Andreessen and Chris Dixon of Andreessen Horowitz, while Katie Stanton’s Moxxie Ventures receives support from Bain Capital Ventures.

Safeguarding Existing Investments

While some suggest that large firms have excess capital, they are also focused on protecting their existing investments.

This was evident in 2015 when Kleiner Perkins explored a merger with Social Capital, founded by Chamath Palihapitiya.

The deal ultimately failed due to disagreements over leadership. Kleiner Perkins subsequently underwent significant management changes, while several Social Capital members departed to establish Tribe Capital.

Venture firms continue to monitor managers who they believe could enhance their brand.

The Appeal of Established Brands

The prestige and financial stability of a large brand are attractive, and joining forces can be less challenging than independent operation.

Semil Shah, an early-stage investor, believes it’s “natural to assume that lots of new rolling funds” will either “burn out, stay small, or try to scale and realize how hard it is and perhaps go to a bigger firm once they have established a track record.”

Resistance to Acquisition and the Value of Independence

Concerns About Consolidation

However, this scenario is becoming less appealing. Eric Bahn, co-founder of Hustle Fund, predicted on Twitter that established VC funds will acquire emerging VC funds building unique networks and brands.

He expressed reservations, stating, “Not sure how I feel about this. 🤔”

Bahn explicitly stated on Twitter that Hustle Fund is “not for sale.”

Preserving Diversity and Inclusion

Bahn voiced concerns about industry consolidation, citing historical exclusionary practices regarding women and underrepresented groups.

He noted that some limited partners still favor male candidates with computer science degrees from Stanford, leading him to fear that even well-intentioned teams might revert to established patterns.

Protecting Franchise Value

These sentiments echo those of Qadree, who emphasized the importance of conviction in building one’s own franchise and the unwillingness to relinquish equity, branding, and innovative ideas.

The Future of the Venture Capital Landscape

Evolving Relationships

Lolita Taub of The Community Fund is optimistic about emerging managers’ ability to remain independent.

She envisions established players increasingly funding and nurturing smaller funds with overlapping interests, extending the model of utilizing scouts to identify promising startups.

“I think older players are looking to expand their reach beyond what they know.”

Inevitable Consolidation

Regardless, the industry is undergoing transformation, and some degree of consolidation appears inevitable once funding slows.

Some firms will thrive, others will merge, some new investors will join established firms, and others will cease operations.

The Mechanics of Acquisition

The acquisition of a smaller fund by a larger one is relatively straightforward, according to fund administration expert Bob Raynard of Standish Management.

It typically involves changes to the general partnership entity, resulting in a shift in control of the funds, and potentially rebranding.

The primary challenge lies in reaching an agreement on valuation, which depends on available alternatives.