Opportunity funds catch fire–VCJ cover story


1310324-cropped

In mid-March, Upfront Ventures disclosed in a regulatory filing that it was raising a $100 million opportunity fund. Later that same month, Social+Capital Partnership unveiled plans for a $150 million opportunity fund of its own.

The two firms aren’t the only early-stage partnerships to seek money for pro-rata and expansion-stage deals.

Greycroft Partners closed a $200 million growth fund last year shortly after Spark Capital announced it had raised $375 million. Homebrew kicked off its $35 million Moonshine fund early this year and Azure Capital Partners is out raising growth capital.

Opportunity funds—which some refer to as growth funds—are a trend in venture capital and more are likely. As capital commitments grow, their impact could be felt on deal competition.

They are in large part a reflection of the bull market now running through public and private equities. That’s because they offer early-stage investors the opportunity to benefit from portfolio winners and other later-stage bets in a rising tide of valuations. They are, in that sense, a different animal than the late-stage growth funds managed by large multi-stage VCs.

With value creation moving from the public to the private markets, these firms hope to capitalize on a generation of rapidly growing portfolio companies.

This makes sense. Early-stage valuations are certainly more reasonable than later-stage ones, and if a nice mark-up comes with a later round, why not take advantage of a pro-rata allocation or build a position beyond pro rata before valuations spiral into the stratosphere? Up to now, early-stage funds have had trouble coughing up, say, the $10 million pro-rata contribution that might be expected in a $60 million or $70 million Series C round deal. Now a $100 million growth, or opportunity, fund can write the check, easing fears of the capital concentration in the main fund.

This becomes an easy calculation for a GP who has spent hours in a portfolio company’s boardroom getting comfortable with its business model and competitive positioning.

Firms such as Union Square Ventures and Foundry Group helped pioneer the opportunity trend and have done well. The Foundry Group Select Fund from 2013 boasts an IRR of 36.01 percent as of November, according to a portfolio report from the University of Texas Management Company. Capital calls have been modest.

USV’s first opportunity fund from 2011 is doing even better. It had a 62.98 percent IRR as of November, according to UTIMCO.

Perhaps the big question is whether opportunity funds will alter the competitive landscape. Up to now, it has been hard for small early-stage firms to make credible claims they have the capital to support companies through expansion rounds. It is a knock that bigger well-capitalized, multi-stage Silicon Valley firms have used for years to sway entrepreneurs. This could change, and a downturn could make it a more convincing selling point, should capital become tight.

So far, the number of early-stage opportunity funds has been modest and their impact on the overall dynamics of growth investing small. Many founders are more interested in whether seed and early-stage firms can line up future investors rather than come up with the cash to maintain pro rata in new rounds.

One firm thinking about the competitive dynamics is Greycroft. With opportunity funds, smaller firms can now make the same pitch Silicon Valley firms have made for decades, that they have the resources to support companies through multiple private rounds, said Partner Ian Sigalow.

“I believe it helps in the decision process for an entrepreneur,” Sigalow said. “Those are all arrows in your quiver.”

The argument could find special traction in New York, which doesn’t have many growth funds. Greycroft, which has an office in New York, could use its opportunity fund to help keep companies from traipsing off to Silicon Valley to raise rounds of more than $10 million or $15 million.

Greycroft’s fund has a mandate to invest in new companies as well as portfolio companies. It so far has made five investments, four of which were portfolio companies. Two of the five have been marked up in successive rounds, suggesting a good start. Over time, Greycroft expects the split between portfolio and non-portfolio companies to be 50/50.

This story first appeared in affiliate magazine Venture Capital Journal, which is published by Buyouts Insider. Subscribers can read the full story, an accompanying table and sidebar by clicking here. To subscribe to VCJ, click here for the Marketplace.

Photo source: ©iStock.com/MirekP

FUNDRAISERS: Don't miss Emerging Manager Connect West 2018 in San Francisco on May 1! CLICK FOR DETAILS!