Tuesday, March 29, 2016

Seed Fund Investment Period "Vesting"

I've grown worried lately as tales of Lake Wobegon are fewer and farther between these days and not all the unicorns are good looking and the seed funds are above average.  What I'm most worried about is the Valley startup employee mentality toward employer loyalty and tenure with employees jumping from one startup to the next as their options vest and they chase unicorn employers with the hopes of finding gold in them thar hills. I think we've begun to see this spill over into the seed fund universe where former founders/startup employees who made a little cash began angel investing and then decided to become fiduciaries and manage Other People's Money (OPM). There is an increasing number of seed fund GPs who view the investment period of their funds as the term of their funds and are leaving 1-3 years into their new-found careers as venture capitalists. I know we're the "limited" in limited partner, but these are still partnerships. We're seeing a number of GPs leave because they "always wanted to be an entrepreneur".

Generally, employee options vest over four years with a one-year cliff. Wouldn't it be great if all of these newly-formed seed funds had similar vesting, whereby if all the GPs didn't stay for a full four-year investment period, that the LPs got to keep that portion of the departing GP's carry? If a company is saying to its employees, after four years, it's clear that you have earned your keep and we value you, isn't there a pretty solid argument that GPs should have to earn their keep (at least new ones) over a four year period as well? Because of the pace of deployment by so many seed funds in the past three years, there isn't much relief if a few GPs at a firm bail, or all of them frankly, because a key person event is generally only trigger-able during the investment period.  If everyone leaves after the investment period, LPs are generally left with the choice to dissolve the fund with a 51-85% vote and receive illiquid in-kind stock certificates, or let whichever GPs are left let it ride. Maybe the remaining GPs raise a successor fund, or they slowly exit stage right. Maybe the workaround is to only invest in seed funds that don't follow-on after the seed round.  At least then, if a GP or several GPs leave, there isn't much left to manage out. The cooling in the markets is likely only beginning and I'm worried about what this foretells for the countless new seed funds that were raised in the last 2-4 hours (oops, I mean years).