Rolling funds are all the rage

Back at the beginning of the year, AngelList launched “rolling funds”. While several funds have launched in the intervening 7 months, last week Gumroad founder Sahil Lavingia launched one, which got them all over the VC-twitter universe. Rolling funds are an interesting alternative for small LPs and new GPs looking to start something. The way venture capital works is general partners (GPs) go out and bang on doors to raise money for a “fund”, which invests in early-stage ventures. Typically, the doors they’re knocking are other large, institutional funds, which typically allocate a portion of their fund to high-risk investment as part of their diversification plan. So, the Harvard Endowment, the NYPD retirement fund, and so on, may set aside something like 2% of their funds to invest in these high risk ventures. Those fund managers give portions of those portions to VCs. Those making the investment in the venture fund become limited partners (LPs). These venture funds are typically between $100 million and $1 billion in size, and the GPs look to invest that money over a period of time (typically something like ten years). The GPs make money in two ways — they charge a management fee, and a “carry”, which are typically around 2% and 20% respectively. The management fee funds day-to-day operations (the salaries of the GPs, analysts, office-space, etc…), and the “carry” is where they make their real money. Once the fund has returned the initial investment, the GPs earn 20% of everything that’s made beyond that. So, if I have a $100 million fund, I’ll have about $2 million per year to operate the business (2%). If I invest that $100 million in nine companies that fail and one company that becomes a unicorn and gets sold for $1 billion in eight years, and of which I own 20% (typically, multiple rounds of investment will be required, and while a Series A investment might normally be for 40% of the company, that ownership dilutes over time) then at that eight-year point I get paid $20 million (the fund owns 20% of $1 billion value company, $200 million; I return the original $100 million invested, and I make 20% of the remaining $100 million in profit, with the other 80% going back to the LPs as their profit).

Most VCs are not nearly this successful. From 2000–2009, the top quartile of VCs returned from 5.12%–20.53%, while the bottom quartile returned -6.87% to 7.35%. The S&P 500 returned about 9.9% per year. And VC is way less liquid than the stock market, and it is not countercyclical since VC success depends directly on exits — either M&A or listing on the stock market. So, to invest in a VC fund successfully, you need to invest in the very best VCs. That’s a pretty strong argument for LPs to only invest in the top end. However, not all LPs are created equal.

If you’re Harvard or the NYPD pension, you can get into the next NEA or Sequoia or Bessemer fund; but if you’re an ultra-high-net-worth individual or a family office — never mind a typical angel investor looking to put in a couple $100k per year — you don’t have access to any VC funds, let alone the best of the best. Similarly, if you’re trying to break into the VC world, you have no chance as a first time GP of raising funds from the big guys, so where do you go? AngelList’s rolling funds provide a vehicle for both.

“Under its structure, fund managers raise a certain amount of permanent capital, then set up quarterly commitments that roll in automatically. New backers can join each quarter, with funds that haven’t been invested rolling over to the next. The fund manager accepts the same management fees and carry as with a typical fund, with the ability to invest throughout the cycle as soon as the first commitment has closed.” Which means first time GPs can raise a small initial amount of money from HNW individuals and get going immediately, and smaller LPs can commit to, say, $25k or $50k per quarter for subscription.

The risk, of course, is that these are new, usually unknown GPs, and so you’re taking a much larger risk than going into an established venture fund — but then again, you can’t get into that established fund, so ¯\_(ツ)_/¯ . And it’s great for entrepreneurs, providing more sources of capital during the start-up phase. If you’re raising funds, you should definitely look at these AngelList options. Equally, if you’re looking to put risk-capital to work, this may be preferable to sourcing your own angel investments.

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Chris Richardson has strong opinions on just about everything. Just ask.