There are many challenges when you operate a smaller fund. One of them is how to make the fund bigger without investors. Entrepreneurs run into the same thing.
One way for a fund to do it is to get into good deals.
We know we are onto something when a big bank like JP Morgan Chase writes a post illustrating a part of our investment thesis. What we are doing is going to be big. It’s a new frontier.
At West Loop Ventures, my partner Kenny and I have been thinking deeply about this. We are very sensitive to forming syndicates and I am intimately familiar with investing as an angel. Fund investing is very different from angel investing and how you form syndicates is different too.
When you are running a capital call fund, you have three goals:
- Maximize return for our bosses (investors).
- Help build great companies
- Make enough to pay the mortgage
That list is ordered by priority and conflicts occasionally happen. Conflicts are generally easily managed.
When you’re running an angel investor group your goals are different:
- Make enough to pay the mortgage
- Help build great companies
- Have fun and build community
Angels have lots of conflicts all the time. It also is herding cats.
If I was going to form a syndicate to invest in a firm as an angel, I’d hit the usual suspects up and then try to find any warm body that fit IRS investor profiles to come into the deal. I wouldn’t worry about percentages, carry, getting paid or anything like that. If the money was green and not laundered it was good.
That doesn’t work for committed capital funds like ours. We’re only at the table in the first place because our investors trust us with their capital to be there. If we syndicated out a deal we’re effectively giving away their ownership interest for free.
That doesn’t sit well with us.
So instead we decided to structure our syndicates so our investors continue to benefit. We thought for a long time on this. Here is how we are doing it. We’d love your feedback.
- If you are an LP in West Loop Ventures, when you invest in the syndicate you pay a 20% carry. That 20% carry goes back to all the LPs in the fund. You don’t pay a management fee for the syndicate but incur small costs of syndicate setup and accounting for operation.
- The feedback we have gotten from LPs is they love this. They get to put more money at risk if they want to.
- They get 80% of the upside for themselves, but since they are LPs, they get a piece of the 20% too.
- They also stressed that the sidecar has optionality. If the fund were to decide to exit a deal, it could. The sidecar wouldn’t be compelled to exit if the members didn’t want to.
- We thought it was pretty fair to everyone and our top priority is the interest of our primary fund investors. A lot of potential investors we have spoken with have told us, “Just send us your deal flow”. Deal flow is one key strategic asset of a venture fund. Sending it for free to a one and done investor doesn’t help our LPs or companies.
- If you aren’t an LP in our fund, the rules are different. When you invest 20% of the upside still goes back to all the LPs in the fund. You also are charged a one-time non-refundable fee to set up and administer the SPV. That fee goes directly to the GPs in WLV and is currently a flat 10% of the investment. We see some really big advantages to this structure that protect fund LPs, help companies we invest in, and give some benefits to outside investors.
- If you have never invested in venture before, the syndicate allows you to try it out for low costs and potentially high return.
- If WLV does a deal you have high expertise in, the syndicate allows you the flexibility to invest in it and add value right away.
- If you are interested in becoming an LP in our fund, the syndicate allows you to get to know us, see how we work, and develop a relationship with us.
- The syndicate allows investors who are more comfortable being Series B investors to invest a little earlier and guarantee themselves a seat at the table when a Series B round happens. It is more challenging to get into a B round than a seed round.
- Some don’t like the fee schedule at all, but we have to protect our LPs. It would not be fair to them if we didn’t charge something. Our fund is extremely fee friendly. We give back our management fee on exits before we see a penny of profit and already charge zero fees on Series B investments and later. We also recycle management fees so more investor money gets put into more companies giving us greater opportunity for success.
- We also intend to co-invest with larger venture funds that are organized similarly to ours. We seek them out on a deal by deal basis based on the needs of the entrepreneur. We know it’s important to be as strategic as we can at the earliest stage possible. The less commodity money or “one and done” investors you can have on the cap table the better it is for the company. Goes without saying, but we don’t ask for any fees from angel groups or LP Funds.
- In the interest of protecting our LPs, we know there are investors who might try to piggyback the fund and not commit capital but invest in syndicates. The truth of the matter is over the life of the fund, we will invest in 20-30 deals. Every deal won’t have a syndicate attached to it. Often, there won’t be room. Only our LPs are guaranteed exposure and the ability to follow-on invest for no fees. If you aren’t in the fund you will miss out on a lot of deal flow.
- Every syndicate we initiate will have a maximum 5% fee associated with it. That fee pays for all the legal and accounting costs for operating the syndicate for the life of the syndicate. We have to pay to set up the LLC, pay the lawyers, and pay a yearly accounting cost to issue K-1’s and file a tax return. This is one thing I started at Hyde Park Angels that has worked really well. Instead of pulling money out of the investment-and out of the hands of the entrepreneur, the investors pay for themselves. Every single person investing in the syndicate whether they are an LP or not an LP pays this fee.
In case you were wondering we looked at doing something on some of the crowdsourced platforms. We observed a couple of things.
First, our fund is highly specialized. We only invest in B2B Fin Tech. The niche strategy might not work for crowdfunding.
Second, the transactions that get done are generally all West Coast centric. We were worried an unfilled syndicate could potentially hurt the company. It also felt a little messy when we thought about how that syndicate would interact with our current LPs. We still might set one up, but haven’t yet.
If you are interested in participating in a syndicate, email us here.
We know other funds syndicate deals and follow on rounds. We decided to do it with a different twist. As far as we know, the way we are doing it is not the norm. However, we believe this is a great way to ensure our investors are put first and companies get the resources they need for success. Don’t worry about us, we will figure out how to pay the mortgage.