Should you give an anchor investor a stake in your fund’s management company?

Raising capital for a new fund is always hard. But should you give preferential economics or other benefits to a seed anchor investor who makes a material commitment to the fund?

These “VCs for investment management companies” are also known as GP stake investors or fund platforms. According to DocSend, “About half the VC firms in our survey had an anchor LP for their fund, and the average percentage that an anchor LP took in a first-time fund was 25%. The prevalence of anchor LPs among both early-stage and more established firms in our data suggests that securing an anchor investor can be crucial for signaling a firm’s credibility to other potential LPs.”

However, data about whether those anchors received preferential terms are very hard to obtain.

“In the hedge fund world, fund platforms are common and therefore more transparent,” Ha Duong, the investment principal at Ocean Investment, a single-family office based in Berlin, told me. “In venture, I haven’t seen many fund platforms.”

A number of firms provide infrastructure for emerging VCs, including Capria, Draper Venture Network, Oper8r and Recast Capital and may provide capital or assistance in raising capital.

However, this ecosystem is much more built out in the private equity and hedge fund spaces. Examples include Archean Capital Partners, Gatewood Capital Partners, Lafayette Square, Nesvold Capital Partners and Reservoir Capital Group. Certain family offices also make these investments on an ad-hoc basis. As do some VCs: LuneX.com notes it is a dedicated blockchain and cryptocurrency fund that partners with a Southeast Asia-based VC, Golden Gate Ventures.

A GP stake investor brings some significant advantages:

• Meaningful upfront initial capital, usually greatly shortening the lengthy fundraising process. This can be particularly helpful for founders who do not come from a wealthy background and may not be able to forgo an income for an 18-month fundraising period.
• Credibility. This is proportionate to the stake investor’s credibility. Everyone else will assume the GP stake investor did extensive due diligence.
• Assistance in business development, marketing, risk management and governance.
• Ability to access LPs who require meaningful assets under management (AUM) before they’ll consider you.
• Back office, in some cases.

There can also be meaningful disadvantages to working with a GP stake investor:

• Typically lower initial revenue because the GP stake investor gets a share of the management company’s revenue. The hedge fund world has a much more developed seeding ecosystem, so I’m using that asset class as a source of benchmark data. The typical share of the management company’s revenue is 15%-25%, according to research on hedge fund seeders from Dechert, Scaramucci and Pensions & Investments. A hedge fund stake investor might also get charged discounted management/carry fees on the AUM they contribute (1%-1.5% management fee, 10%-15% carry, according to Troutman Pepper). “Before 2008, a widely accepted rule of thumb was for a [hedge] seeder to expect 1% of revenues for each $1 million of seed capital, according to The CAIA Association. “Though this rule breaks down quickly as seed transactions reach and exceed $50 million, at smaller transaction sizes, the rule still seems to hold. In some instances, terms may be even more favorable to the seeder than the 1% per million rule of thumb.” This revenue share will normally extend for five to 10 years. However, small AUM funds may not do a revenue share because they don’t have much cushion after paying modest salaries and setting up basic infrastructure.
• Typically less long-term upside. Hedge fund seeders will typically get 1%-10% of the management company for a working capital infusion, according to Troutman Pepper.
• Fewer degrees of freedom. A strong lead investor may expect to have more of a say than a typical LP in how the fund is operated and its investment choices.
• Potential difficulty in disentangling if it makes strategic sense to do so.
• Greater risk. You have a primary point of failure, and a really dominant anchor means you have a boss, which most founders are trying to avoid. A diversified shareholder base is healthier in the long term.
• Other potential LPs may have concerns about the relationship. Marco Cesare Solinas, an analyst with Blue Future Partners, observed that the anchor inevitably affects incentive mechanics, decision-making and focus of the fund, which may be weighted toward the anchor’s particular interest.

“If the anchor is closely tied to a particular person or persons on the management team, the dynamics have to be examined closely to minimize the risk that there will be extra pressure placed on those persons with a relationship with the anchor or the risk that extra pressure will be placed on the persons not affiliated with the anchor,” lawyer Emily Campbell, the founder and managing member of Campbell Firm PLLC, said.

“Doing some ‘what ifs’ — including what if the anchor’s goals change or what if the persons with whom the anchor is affiliated want to move on to other opportunities — will be important so that the team can go into the venture with their eyes wide open.”

Does your VC have an investment thesis or a hypothesis?

Here’s what I recommend sharing with the stake investor as the possible “gives” in your sales pitch:

• Economic benefits: possibly a lower management fee and/or a stake in the GP’s economics.
• Deep transparency into decision-making and firm management processes.
• Complimentary and complementary due diligence. The LP can ask the fund to complete due diligence and prepare an investment memo on any company that fits our mandate.
• Cross-marketing of LPs, co-sponsorship and speaking slots at annual LP conferences and jointly organizing events.
• Best-efforts commitment to raise capital for joint SPVs and joint fund anchoring.

Very few people publicly discuss this issue. One exception is Lo Toney, founding managing partner of Plexo Capital, who has publicly discussed selling a stake in your GP.

It ultimately may come down to timing.

“The best time to raise capital is when you can,” Capital Introductions CEO Victor Park said. “If given an opportunity to take seed capital on a discounted fee basis from an anchor investor, I’d always do that deal on a vehicle-specific basis. If the seed and/or anchor investor asks for a percentage of total fees for any future investors across other vehicles, I’d try to negotiate specific performance criteria required of that anchor investor: serving as a reference; full press rights on the use of their name; and, if possible, even introductions to their end clients.”

Disclosures: Blue Future Partners is a member of the LP Advisory Board of ff Venture Capital, where I was formerly a partner. Emily Campbell has advised me on some legal matters.

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