You asked, and Beezer Clarkson answered.
A new feature launched by pehub and affiliate publication VCJ allowed you, dear reader, the opportunity to Ask an LP questions about the hottest topics in venture. Anything was on the table and open for discussion, whether it regards secondaries, what keeps an LP up at night or their feelings on today’s lofty valuations for tech startups.
Clarkson, managing director at Sapphire Ventures, answered the first round of questions that came in.
Q: What is the ideal fee structure to best align GP and LP?
A: One that is fair and transparent.
Given the range of fund types, plus potential discounts for anchors, I don’t think there is a “one size fits all solution.” But the greater the transparency on what the fee is being used for (meaning sharing the firm’s budget on a routine basis even if the fee itself is not “budget base”), and stepping down in the post investment years when a successor fund has been raised, greatly increases GP-LP alignment.
LPs know it costs money to run a business. They just want to know where the money is going and how much.
Q: How important are a GP’s office locations when an LP is examining the branding and potential deal flow of the general partner?
A: How GPs run their business, including where (and how) they spend their time reflects how they are executing their strategy.
LPs look closely at the alignment of a fund’s stated strategy, its execution and the resulting track record. A GP’s office location can most certainly be a critical component as presumably a fair bit of the GP’s time is spent there. How they use that space sends a message to the community (entrepreneurs and LPs alike).
Be intentional in the message you are sending. What speaks louder than a ZIP code, though, to an LP is DPI (Distributions to Paid-In Capital).
Q: VCs sometimes turn down seed opportunities because they are “too early” or “have no traction.” Other times they back deals because of a stellar team or a first customer commitment. When a first-time or emerging manager approaches an LP who doesn’t typically invest in first-time managers, what equivalent signals can the manager show the LP to overcome the “too early” objection?
A: Do you know why the LPs in question don’t typically invest in first-time managers? If they are restricted from doing so or for some other reason are just not going to invest in a first-time fund, don’t pitch them.
Ask instead to introduce yourself and start building a relationship now for Fund II or later. The same way entrepreneurs will tell a VC about their company early to “get to know each other,” LPs respond very well to the same.
If you don’t know why, ask them. In their answer, you might find yours.
One of the most powerful reasons I have seen that motivate LPs to invest in first-time funds are the belief that the first-time fund is the best way to get involved in a new investment category perceived as additive to the LPs’ portfolio and offering promising returns.
Also, endorsement by a fellow LP or GP who a) has a track record for calling new opportunities early and right, and b) is participating in the fund.
Q: What “red flags” would stop you from investing in an upstart firm’s debut fund (or co-investment deal)?
A: The red flags include:
- Me too, or an undifferentiated product.
- Team history. Have they tried and failed at this strategy in the past? Is the debut fund strategy in wheelhouse of GP?
- Premium economics/difficult legal terms for an unproven team.
- High level GP diligence coming back less than stellar.
- If GP team members are simultaneously raising a fund or interviewing to join a different fund.
- High level diligence turning up that the deal has been widely shopped.
- Fuzzy reasons as to why the fund isn’t taking the whole deal – or, in other words, why am I so lucky to get this co-investment opportunity?
Q: What would you need to see and like to see from an upstart firm’s debut fund?
A: I’d want to see:
- Differentiated product in general as well as additive to my own portfolio in particular.
- Strong rational as to why this team for this opportunity.
- Compelling previous investing track record.
- Belief the GP is “in it to win it” and understands the long term nature of creating a fund and the associated fiduciary responsibility.
- Evidence team has worked (well) together before – perhaps at previous fund.
- Meaningful GP net worth contribution.
- Clean terms.
You can send your question(s) to the email address below and LP Beezer Clarkson, managing director at Sapphire Ventures, will answer them on the VCJ and peHUB websites. Last month, Clarkson wrote on the “Top 10 tips for pitching an LP.” Your question to Clarkson will remain anonymous unless. Send your email to me at firstname.lastname@example.org with the subject line ”Ask an LP.”
Disclaimer: Beezer Clarkson’s opinions do not constitute investment advice and under no circumstances should any information provided be used or considered as an offer to sell or a solicitation of an offer to buy an interest in any investment fund managed by Sapphire Ventures. Sapphire Ventures does not solicit or make its services available to the public and none of the funds are currently open to new investors. Past performance is not indicative of future performance.
This story first appeared in affiliate magazine Venture Capital Journal, which is published by Buyouts Insider. Subscribers can read the story by clicking here. To subscribe to VCJ, click here for the Marketplace.
Photo illustration from Shutterstock.