When London-based Episode 1 Ventures recently closed its third fund on £76 million (about $96 million), there was something different about its LP base.
Founders made up more than a third of the investors in the new vehicle, a departure from the LP makeup of earlier funds.
As VC firms mature, high-net-worth individuals and single-family offices tend to play second fiddle to institutional LPs that can write bigger checks.
But GPs are increasingly tapping into that network of high-net-worth investors, who are eager to access premier funds.
“We rang around and spoke to entrepreneurs that we know and that we backed,” said Episode 1 general partner Hector Mason. Those entrepreneurs-turned-LPs include Zoopla founder Alex Chesterman and Aron Gelbard, founder of flower delivery company Bloom & Wild.
Institutional LPs are reducing their exposure to the asset class by cutting commitments to emerging managers or first-time funds and selling fund stakes on the secondaries market. They’re also making fewer “pilot checks” to try out GPs, according to Jordan Stein, director of private capital at Cresset Partners, a multifamily office that has committed to Andreessen Horowitz, Lightspeed and Founders Fund.
“Either funds get smaller or they say ‘I’ve got to figure this out somehow,’ and they go the single-family office, multifamily office, ultra-high-net-worth individual route,” Stein said.
Putting aside the Andreessen Horowitzes of the world, GPs across the board are struggling to fundraise. In 2023, US venture firms raised $66.9 billion across 474 funds, less than half of 2022’s capital raised, according to the Q4 2023 PitchBook-NVCA Venture Monitor. New managers have it the hardest: 75.3% of that total went to established managers.
Even these established managers are struggling to secure commitments.
“These are groups that have never really struggled before. They have good performance. It’s just really tough,” Stein said.
Founders love founders
High-net-worth investors are one group that can help emerging managers plug the fundraising hole. In particular, GPs are attracted to bringing on former founders as LPs, both to help with deal flow and due diligence—and as a selling point to potential portfolio companies.
Research published by economists Paul Gompers of Harvard Business School and Vladimir Mukharlyamov of the McDonough School of Business at Georgetown University suggested that founders who’ve had a successful exit also have an edge in betting on the right startups, in part because of the extensive network they developed.
“[Founders] help us win deals in the future because any time we’re competing for a deal, we introduce a new founder to our existing founder base, and that’s usually our winning sales tactic,” said Priya Saiprasad, co-founder and general partner at Touring Capital.
Led by three alumni from M12, Microsoft’s venture arm, Touring Capital has secured backing from more than 25 founders in its network. This LP subset includes founders who took investments from Touring’s partners, and who subsequently sold their companies.
Founders who sell their companies are willing to take risks and often want to pay their good fortune forward by backing the next generation of software founders, according to Grant Silow, managing director at 25madison, an early-stage venture firm and incubator.
By their nature, high-net-worth individuals are more fickle than institutional investors, which often cultivate their GP relationships over decades. While founders and family offices may be willing to take bets on unknown names, they’re also quick to bow out of a fund if they have a change of heart.
Private equity fund managers are increasingly offering perpetual entry and periodic redemption in funds dedicated to ultra-high-net-worth individuals in order to cater to individual investors’ risk appetites.
In venture, a single seed round has the potential to deliver the returns of an entire fund. Because it’s a high-risk industry that involves placing moonshot bets on small companies, ultra-high-net-worth individuals and single-family offices that aren’t as familiar with the asset class can underestimate how much manager selection matters.
Stein explained that some high-net-worth investors may think “I like this person, I like this strategy, I like this team” without quite realizing how much access to deal flow can make or break a new fund.
Featured image by Richard Levine/Getty Images