Thursday, March 26, 2015

LP Portfolio Construction in Emerging Managers

It's as important to chose your LP portfolio as thoughtfully as you construct your portfolio of companies.  I say this especially when it comes to seed funds that are emerging today because the risk that something is going to go "wrong" within a new seed fund partnership today is high. This is in part because the barriers to entry to become a seed fund VC are lower than at any point in the venture industry's history and one doesn't need a track record as an institutional investor, or have managed Other Peoples' Money (OPM) prior to raising a $25-30 million seed fund. You may only need an angel track record or been a highly successful entrepreneur. When I say go "wrong" I mean that you'll actually have to read and follow the language of the LPA that Cooley or Gunderson so artfully drafted. In just the past four years, the seed fund landscape has already seen key man events, time and attention limitations, investment opportunity conflicts between funds (especially with the rise of opportunities/select funds), as well as issues regarding investment period terms among others. Given the low barriers to entry to become a seed VC today, it only seems to foretell that if the frothy market of today turns against the industry tomorrow and many of the 200+ seed funds raised in the last several years aren't able to raise a successor fund that the seed fund industry will see even more LPA terms come into play with more serious issues in play. It isn't that hard to imagine seeing GPs walk away from funds after the investment period when they can't raise a follow-on fund, raising serious governance issues when the keys are handed back to the LPs. This is why I think it's really important to think about LP portfolio construction when raising a fund because there are so many new LPs that have lamented venture for 10-15 years and are rushing into the emerging seed landscape because it's an easier beachhead to land on today than fighting to get into high roman numeral funds with long track records and waiting lists of institutional LPs out the door. It's also important not to just pick an LP because of the institution, but rather the actual individual(s) at the institution leading the investment. Venture LPs come in all shapes and sizes (foundations, endowments, fund-of-funds, family offices, insurance companies, consulting firms, corporates and pension funds).  They're easy to find on Preqin, but what isn't as easy to find, are really value-added and experienced LPs who have been through an LPA by experience and have lived through how to deal with all the issues that could and very well may come up over the life of a seed fund partnership.  Although LP stands for "limited partner", find people who are more partner than limited. That's why I admire LPs like Russ Hall at Legacy Ventures and Michael Kim at Cendana Capital, because they've been on both sides of the GP/LP table and are a beacon for finding signal amongst the noise in all weather.  

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