Financially Attractive Venture Capital Funds to Invest in
Top Venture Capital funds — think of those whose managers appear on The Midas List — have historically returned astonishing profits to their investors (Limited Partners, LPs). But established top performing oversubscribed VCs are difficult to access, especially for individuals, small Family Offices and emerging or small Fund of Funds. The VC sector is full of interesting out-of-the-box opportunities, and this article will uncover some exciting strategies out in the market. Disclaimer: not an investment advice.
TLDR, 3 categories:
- Emerging Managers: “reverse carry”, arbitrage -focused (geographic, minorities), access microfund (coinvestors, program-backed).
- Two-sided Securities: token warrants, guaranteed hybrid-debt models, garanteed securities.
- J-curve Driven: last closings (seed funds, opportunity funds), secondaries.
Emerging Managers
💰 “Reverse” Carried Interest mechanisms: atypical fund structures
A 3,25x liquidated portfolio multiple (MOIC) would normally return around 2,5x net multiple (DPI) to LPs. In those next particular funds, LPs could instead get 2,75x-4,5x net.
- First type: sharing the carried. Most fund managers charge a 20%+ “success fee” (carried interest) after a minimum return (hurdle rate) is delivered to investors. Nonetheless, some waive the fee for first LPs committing (especially if there joined a precursor vehicle), or even include them in the distribution structure of that 20%.
- Second type: cornerstone LP sharing their profits once their low minimum return is ensured. Think of a Public Institution (like the British Business Bank or Fond-ICO) or a non-profit that decided to commit a big chunk of the fund for the purpose of boosting the startup ecosystem in a VC-deprived region or for the purpose of encouraging astonishing emerging managers. In those cases, you could expect the fund to return to investors more than what they could have made had they directly invested in a single company.
🌍 Geographic arbitrage: Rocket Inernet-ish
The fund investment thesis is built around emerging or winning business model-driven products within a specific sector, but where the experienced managers think the model could be replicated and better succeed in another geography.
👧🏽 “Minorities”-focused funds: mark-up arbitrage
There are funds that focus on backing specific founders such as Women, Ethnic (black, latinos, immigrants…), low-income, LGBTQ+, and whom mainstream funds would pass on or neglect for having “crazy” ideas, poor soft or social skills, unattractive target market or other. The fund here, faced with little or no competition, would make a high bet funding the pre-seed or seed round of the company at a low valuation, prove its thesis when the company traction rises and then bring on top funds for the Series A, ensuring a 3x-7x (higher than usual) fair value mark-up for the investment.
Tip: make sure of the connection between emerging managers and top funds, and that the manager’s business plan is executable with the fundraised amount.
🤝 [Top] Coinvestor-driven funds: copycatting portfolios of top funds
Some top-tier funds allow small funds (or microfunds of $2M–$15M) to coinvest with them for a particular reason, like:
- the value their emerging managers can add to the startup, like doing the hands-on work such as preparing founders reach product-market fit while top funds prepare to sit on the board starting the Series A.
- scouting — they are a reliable source of dealflow.
- covering parts of current round or follow-on rounds, for example in order not to cede political rights to third parties.
Tip: make sure the fund directly invests in companies and not via SPV structures.
👩🏫 Program-backed microfunds: the next YCombinator or 500Startups
Think of an emerging accelerator, platform or incubator which is sector or region-specific and which is launching a small fund to back the best startups of their program. Some rely on spread-and-pray strategies while others cherry-pick their deals.
Tip for microfunds: focus on their exit strategy. Those funds tend to have a tiny % of the company, so unlike big funds, can sell their shares via secondary much easily.
Two-sided Securities
⛓Token warrants: first movers in blockchain applications
Wherever the regulator allows it, it is becoming common that 2022+ funds, irrespective of the sectors they invest in (like biotech or education), have a clause that refers to an allocation (say 20%) that could be dedicated for unconventional investments such as “Digital Assets” (tokens, coins…) and that is discreetly dissimulated in the Limited Partnership Agreement. In other cases, the fund can only invest in equity or equity-simulating instruments. Nonetheless, smart first market movers found the attractive bottom line.
While the fund is preparing to invest in a company via equity (or convertible) and knowing that the blockchain-based startup is planning to issue a coin, a token warrant is agreed within the deal, granting the investor a share of the total number of digital assets to be issued, usually for free or at a very low price. Before the Initial Coin Offering (1–3 years), managers work hand in hand with the startup on concentrating the value of the company in the token itself, and, passed their vesting period (1–2 years), progressively sell the “liquid” asset on a cryptocurrency exchange. The illiquid equity part of the investment serves as a downside protection (like against acquihires in early phases of the project), and an upside opportunity (exit via secondary, IPO, trade sale…) for extra returns. Blockchain or Web3 -focused VC funds are also an alternative way to gain exposure to the crypto sector, and would potentially have a shorter lifecycle (est. 7–8 years) compared to other funds, hence quicker returns.
Tip: make sure the team has a strong understanding of tokenomics.
⚖️ Other two-sided investment strategies: derisking but lower return on investment. Non-VC funds.
- Hybrid capital-debt models like Venture Debt or Convertible Bonds with default protection (like the EGF guarantee).
- Securities with “guaranteed” returns: Preferred Equity, Search Funds…
J-Curve Driven
⏳ Final closings: derisking and buying time
Final closings are attractive, especially if they occur 12–18 months after the first closing, because during the due diligence the investor gets to see what the managers have invested in and how the startups are performing versus the investment thesis. In some cases, the portfolio already contains early winners — at least on paper (valuation mark-ups from subsequent rounds — and the new investor is allowed to participate in a 1,2x+ TVPI fund by only paying a late entry “equalization” fee to existing investors, which should be a fair price for potentially accelerating the J-curve, like advancing 2–3 years in time (or getting closer to profits) in the case of lengthy seed funds that tend to exceed their 10-year lifecycle. No extra fee shall be paid to account for the new fair value of the portfolio. An approximation of the equalization fee (in $) formula is:
Equalization fee = investor’s commitment x % capital called x [# months / 12] x [% reference interest rate + bp premium]
Reference interest rate could be Libor, Euribor or T-bill on a fixed date and basis points “bp” premium tends to be around 3%, and the number of months is that fraction between the first closing and date of admission to the fund.
Tip: with rising interest rates, and hence high equalization fees, joining a fund late could become less attractive.
Other interesting late-entries are those of opportunity or continuation funds, where normally only LPs of previous funds are allowed to join but “there is a small space left”. Those funds tend to have reduced management fees and carried interest (i.e. 1%-10%) as they operationally require less resources for analysis and back-office, hence having a lower “Total Expense Ratio” (TER) than regular funds. But also lower risk so lower potential return.
Tip: make sure there are no “Conflicts of Interests” associated with such funds.
2️⃣[Emerging] Secondary Funds: buying employees or seed funds shares cheap
Market turbulence causing delayed IPOs and trade sales is stressing early stage investors who need to liquidate their funds as well as startup employees (including founders) who need some extra *cash* motivation to continue with the startup project or to pursue other life challenges. The vultures are watching and are here to provide liquidity - at a great discount.
Tip: managers need to be able to have access to founders, employees and cap tables, and need to master the art of reading complicated cap tables (liquidation preference, options and warrants…) to assess and negotiate a proper share price discount.
Feel free to reach out via LinkedIn if you have any comment!
