Determining the Right Mix of LPs for Your Firm

As you begin to fundraise, you may want to consider the following factors:

Limited partner (LP) diversification.
“No matter the size of the fund, you want to create the most diversified LP base you can,” says Erik Sebusch, partner and global venture capital strategy leader at Mercer Consulting. “If you're raising a smaller fund, the mix looks different than if you're bigger, but the goal is to not be over-concentrated with any one type of LP or geographic area. Overconcentration can be dangerous if there is a market shift, a downturn or a change in strategy for one of your major LPs, for example.”

Right-sizing your expectations.
You’ll likely spend a lot of your fundraising energy meeting with high-net-worth individuals (HNWIs) and family offices (FOs), which are typically the most common investors in emerging managers. Depending on your fund size and your strategy, you may want to spend time with endowments and other institutions, but it’s important to be mindful of your expectations and time spent with these groups, as their processes tend to be long and complex. “Although institutions are in the minority [of emerging manager investments], they are well positioned to write very large checks,” says Winter Mead, of the emerging manager community platform Oper8er. “But those checks aren’t especially useful if they exceed the size of your fund or have a low probability of landing in your fund.”

Lead time.
Given the highly variable diligence processes across the LP landscape, it’s a good idea to build relationships early and bake in ample lead time. “You’re not likely to be able to approach a pension fund the month before your final close and expect that to convert,” cautions Hillary Tyree, a vice president on SVB’s Emerging Manager Practice team.

Investment philosophy alignment.
It’s a good practice to align your firm’s investing thesis and philosophy with that of your LPs. “Some LPs have strict mandates on what they can and cannot invest in and may prohibit investments in some categories like alcohol and cannabis. One of our institutional investors has a restriction on investments they deem ‘reputationally risky,’” said Jeff Weinstein, a general partner (GP) at FJ Labs, in an interview with Kauffman Fellows. “Of course, what a multi-billion-dollar conglomerate deems ‘reputationally risky’ does not always align with the philosophies of forward-thinking venture investors, so this can create some tension.”

LP familiarity with and commitment to venture capital (VC).
Just as we’re seeing a huge growth in emerging managers going out to market, we are seeing a surge in LPs entering the space. However, building a venture firm is a long-term process. Consider building your LP base with an eye toward follow-on investors who can grow with your firm over time.

Potential public disclosures.
Funds that take capital from government entities like public sector pension funds or public university endowments are legally obligated to disclose their returns if a member of the public requests them under the Freedom of Information Act (FOIA), a federal law which ensures public access to information held by government agencies. While this requirement only applies if this information is requested, some fund managers may not be comfortable (or set up administratively to handle) this level of regulated transparency.

Long-term thinking.
When setting out to build an enduring firm, keep an eye toward the future. Even when you’re raising Fund I, think through the LPs you want around the table for Fund III and beyond, so that you can show up today in a manner that begins those relationships.

Patience.
As with any relationship, building authentic and non-transactional relationships with LPs is likely to take time. “Much like with your portfolio companies, the best time to build relationships with LPs is usually before you need them,” says Sebusch, “Often, these are long processes.”