What Do VCs Look For In Their Own Investors aka LPs?

3 min read

If an entrepreneur is looking just for money they should probably raise from sources other than VC. What good VCs do is truly help a company — in the early stages especially with product and go to market, in the later stages especially with business model and exit. Similarly, VCs have their own investors and will often look for other values beyond capital. This post will first illuminate the general structure / terminology around VC and then talk about those other values.

1) Structure / Terminology Of A Fund

Those running a fund are called General Partners (GPs) while those investing in the fund are called Limited Partners (LPs). LPs could include individuals, family offices (basically individuals who have a more formal approach to their investment activity), endowments, pension funds, fund of funds, corporates, among others. It’s common to use the labels “individuals” and “institutionals” broadly to describe the type of LP.

Typically there is an entity for the GPs, a second one for the LPs, and a third one that envelops both the first and the second. This means liability is contained, say a lawsuit against a portfolio company where the VC gets named doesn’t extend into the LPs and vice versa. GPs expect LPs to contribute capital in a timely fashion and the market data is that 99% of the time that is actually what happens. Finally, when a fund says they are a $1B it’s that they have the ability to eventually draw all that capital, not that they have all of it in the bank right now.

2) The Capital Commitment

When a VC funds an entrepreneur they typically wire all the funds at the time of the close. The VC may certainly invest more in the company in later rounds to maintain their ownership (prorata) or increase it (super prorata). But when a LP funds a GP they send portions of their commitment over time, which in the US is typically 10 years. The cadence of those capital calls varies based on the fund strategy but usually it’s front-loaded ie it’s uneven across the 10 years. The norm is a VC makes new investments only in the first 5 years, typically reserving half of the fund for that. Given that most VCs raise their next fund within 3-5 years the investment activity becomes a series of S curves — you continue deploying from the old fund while the activity picks up from the new fund.

3) Coinvestments including SPVs

Many LPs like to invest in companies directly and funds span the whole spectrum of how they work with that interest. Early stage VCs especially tend to be more open to the idea of coinvestment because it gives them additional resources with a startup. The challenge is extra work managing multiple interests, especially in getting enough allocation. Some funds will always charge management fee and / or carry in helping a LP coinvest, others will do on a case by case basis. A Special Purpose Vehicle (SPV) is a common way of formalizing a particular investment where a VC could aggregate both LPs and non LPs in funding a company.

4) Strategic Help: Sourcing, Diligence, Portfolio, LP Intros

Sourcing means helping a VC with leads, whether it be to entrepreneurs, other VCs, or potential partners like a corporate that could do a pilot with a portfolio company. Many LPs are well situated to help given other people and entities they know and / or are invested in.

Diligence is about validating a particular startup and some LPs, with expertise in a particular area, can be especially useful.

Portfolio is the current set of startups in a fund — and they need help with getting customers, hiring people, and eventually raising more money. GPs will often look to multiply their own outreach significantly by relying on LPs.

LP intros refers to the idea that a LP introduces the GP to someone else that could become a LP. It is extremely common, in fact may even be the majority of a fund was an introduction through someone else who had decided to invest. Some individuals, family offices and especially institutionals that are well known in an ecosystem can add much credibility to a VC’s fundraising.

5) Governance: Accountability and Advice

Most of the time GPs control the investment decisions although some funds will have an anchor LP (often >20% of the fund) who gets a seat at the table. Regardless, all GPs send periodic updates to their LPs, such as a quarterly financial statement, detailing their investments. Most funds will also hold an annual event for their LPs. These and other regular communication mean that LPs have visibility into the fund and ensure accountability. In the US some funds create a Limited Partner Advisory Committee (LPAC) which effectively acts like an informal board. The LPAC is commonly an odd number of LPs, somewhere between 3 and 7, that meets a couple times annually with the GPs. Which is why GPs also value having at least a handful of LPs with deep investment experience who can give valuable advice on running the fund.

Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.

Amit Garg I have been in Silicon Valley for 20 years -- at Samsung NEXT Ventures, running my own startup (as of May 2019 a series D that has raised $120M and valued at $450M), at Norwest Ventures, and doing product and analytics at Google. My academic training is BS in computer science and MS in biomedical informatics, both from Stanford, and MBA from Harvard. I speak natively 3 languages, live carbon-neutral, am a 70.3 Ironman finisher, and have built a hospital in rural India serving 100,000 people.

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