Venture funds are typical platforms – servicing their LPs - providers of capital (LPs or Limited Partners - investors who invest in venture funds) and the founders/portfolio companies. LPs provide GPs (GPs - General Partners are the fund managers/VCs who invest in startups) the capital to execute their investment strategy, thus enabling the very existence of venture funds.
As in any financial market, investors are not a homogenous set. Some common investor forms are - High Net-worth Individuals (HNIs), Family Offices, Funds of Funds (FOFs), Development Finance Institutions (DFIs), asset managers, banks, corporates, pension funds, endowments, and sovereign wealth funds. et al. The base expectation for all investor types is financial returns commensurate with the risk taken. In addition, based on their strategic objectives or motivations, LPs might have other expectations from fund managers. For instance, corporate strategic investors may want to see deal flow/pipeline in sector(s) which align with their business or track new technologies and/or market developments. Similarly, for a DFI, the key motivation is the ability to drive their meta-mandate such as growth and development of underserved sectors or segments of the economy. Thus, GPs strive to deliver on multiple counts, with financial returns being a hygiene criterion.
The LP-GP relationship is typically viewed as a uni-dimensional one, a relationship skewed toward LP’s expectations from GPs. However, for GPs who operate with a platform and an institutional building approach, there is significant strategic value addition that LPs can enable. While not often widely discussed, GPs also have expectations from their LPs, which, of course, vary for each category of LPs. These expectations can be plotted along 2 axes – capital and strategic value.
These expectations vary as per the type of investor and the relationship the GP enjoys with them - each category of LPs is uniquely positioned to help the GP and their portfolio companies.
Institutional LPs – such as sovereign wealth funds, FoFs, pension funds, and endowments etc. are the largest source of capital for funds by ability and intent. They commonly select managers after in-depth diligence, as the expectation is that they would be backing a manager over a decade or more, which translates to typically 3 fund cycles (of course, subject to performance). Thus, the GPs would expect them to anchor a fundraise and provide emphatic signals to other incoming investors.
Institutional LPs invest across asset classes and thus have wider exposure to a range of managers. Such LPs are typically a part of the LP Advisory Council of the fund (LPAC – the governing body comprising LPs) they invest in. A Fund manager would expect such LPs to share inputs regarding governance and best practices around managing the fund.
Also, institutional LPs have a critical role in providing references/feedback about the GP to other institutional investors. If a manager is performing well, there is an implicit expectation from their institutional backers to provide introductions to other investors for future fund raises.
Corporate Strategics – are large corporates investing in funds with the twin objective of (i) having visibility in new technology or business models emerging in their core or adjacent business domains, (ii) investing directly in companies via the partnership with the fund in emerging areas which are of strategic importance to the corporate. Given that the larger intent is to partner with portfolio companies, either as an investor or a business partner, corporate strategies potentially bring a lot of value to the fund. In some cases, they are also potential acquirers of businesses that fit their strategic intent.
Family Offices and HNIs – In the Indian context, successful entrepreneurs and business houses from conventional business sectors are increasingly looking at venture funds as a part of asset allocation for their portfolios. Such investors are uniquely positioned to help the portfolio companies of a fund – their businesses can be potential customers or vendors for the start-ups, thus helping them scale up. These investors also actively look at direct investments and can be an important source of follow-on capital for the portfolio companies, especially up to Series A. The experience of building and scaling up businesses on the ground that such investors have is invaluable. Early-stage businesses can derive a lot of learning and mentoring support from such investors.
New-age entrepreneurs/CXOs – Accomplished founders and CXOs who have scaled and exited their start-ups, invest in funds, more often than not with the objective of giving back to the venture ecosystem. With hands-on experience of building scaled-up, exit-ready start-ups, the mentoring, learning, and support that these investors can provide to the portfolio companies is of immense help to the founders. Not only this, given that these investors are a part of the founder ecosystem and have strong established networks, they are also an important source of deal flow and founder referrals to help the fund.
The above is by no means exhaustive, and as already mentioned, LPs are the raison d'etre for funds to exist. As service providers to a 2-sided marketplace (founders and investors), Fund Managers need to ensure that they engage with LPs and align them to the expectations they have across various axes to ensure a win-win for LPs, portfolio companies, as well as the managers. While the financial incentives of LPs and GPs are always aligned, the strategic intent and objectives are aligned as well, and these, taken together, lead to “LP Success”.
The sell-side of Venture CapitalThis is a unique insight and not a lens that is usually applied when people think of venture capital. Most of the people whom I interact with, especially young professionals interviewing for a role with Blume, think a role at a venture…
- Current Section
- Alok Mehta