LPs, the $ Behind the Curtain
For a long time pre the early 2000’s there was very little transparency into how VCs operated, a scenario that arguably gave unfair advantages to investors. This was particularly true in the case of first-time entrepreneurs’ who barely understood how to approach VCs not to mention what some obscure terms in a term sheet actually meant for their future ownership stake in their business. Over the last 10 to 15 years, the landscape has shifted dramatically, driven in large part by a handful of successful VCs that have championed transparency into an otherwise opaque business, mainly Fred Wilson and Brad Feld to name a few. This movement has helped founders better understand VCs’ motivations, processes, and evaluation criteria, and has thus substantially leveled the playing field.
However even today the transparency between entrepreneurs and Limited Partners or LPs (the investors in VC funds) is essentially nonexistent. This is partially for good reason, LPs pay management fees to VCs specifically for their expertise and relationships with entrepreneurs, thereby eliminating the need for LPs and founders to interact directly. However, I think it is worth noting that there is value for founders in understanding more about LPs’ motivations. One reason why this matters is in understanding where VC’s get the money they invest and what their LPs’ expected timelines for liquidity are. For example, if an entrepreneur is building a deep-tech company that may take well over 10 years to produce substantial returns, then a traditional VC fund may not be the right structure as most institutional LPs typically expect liquidity in 10 years or less. Whereas a family office or other non-traditional “evergreen fund”, might potentially be a more patient and appropriate option.
This week Semil Shah shared a great piece on his key takeaways from recent meetings with LPs. This is another step in a slowly growing trend of increasing transparency between LPs and the rest of the venture financing community, including VCs and founders. The Open LP initiative has also recently been launched with the same goal and has consolidated some great content on this issue. One takeaway from Semil’s post is on LPs’ increasing push for exits. This is not surprising given how much longer companies have been staying private in recent years, but it is important for founders to understand the pressure that VCs are under from their investors. Semil specifically points out that LPs are searching for GPs (General Partners aka VCs) that “know how to get out”. While this may make VC seem like a callous business, exits are an inevitably critical part of a healthy ecosystem. The reality is that if investors are not able to cash out of startups investments, then they will never be able to reinvest in new companies.
Founders already have a million and one things on their plate, so surely the last thing they want to concern themselves with is the mindset of endowment and pension fund managers. However, just taking a moment to pause and think about the role LPs play in the ecosystem is worthwhile, especially as founders consider potential VCs to partner with.
-Mike Droesch, Editor
