How Rolling Funds Work From the Inside
How did we create ours in just 10 weeks and what will it change in the venture capital industry?
I can now confess that last March; I was pretty depressed.
COVID 19 was turning our lives upside down, and I'm not talking about having to wear a mask or stay home confined... I had just spent over a year trying to raise The Refiners Fund II, and after a long roadshow trying to convince LPs to invest in our Fund, we were finally about to announce our first initial closing of $15m. The closing date was set for March 27th. Needless to say that the pandemic wiped out our project.
Several LPs that took us months to convince finally reconsidered their initial commitment (and I fully understand it), and soon I quickly realized that it would be impossible to raise the capital needed to launch this Fund. Raising a classic fund requires time, and because of its inherent costs, a substantial amount of initial money if you want to be able to pay yourself a minimum of cash.
I had to reconsider my professional activities suddenly. I seized the opportunity to focus on my family, and what I really like to spend time doing—the best way not to go psycho, I guess. Blogging and podcasting activities have always been something I have been doing this on the side; COVID was the opportunity to bring this activity forward. Not to mention that from now on, everything would be a bit "on the side" since I've decided that the center would be my family and me. I have also engaged in some consulting, mainly for friends I crave to help in their projects and where I think I can bring value. And then by surprise because these things always happen when you least expect it, I started to conceive my own project, I say project for the moment because we can't call it a startup yet. But that's another story I'll tell you more about soon.
In the meantime, I wanted to continue to invest in startups as I've been doing intensively for the last four years (+50 investments). I've been fortunate to build a reputation as a business angel, and helping entrepreneurs by investing in their startups at a pre-seed stage is something I love to do. I think I'm starting to understand a little bit how it works ;-) It would be a shame to give that up. The learning curve for investing is lengthy and requires resilience. At the same time, it was out of the question for me to build up a new fund from scratch. No time for that, and once bitten, twice shy.
That's when I started to talk with my friend Ilan, a repeat founder and fantastic Business Angel based in NYC. At that time, we were both approached by European funds to be part of their US scouting program. Scout programs are exciting, but they bind you to funds that you're not guaranteed to stay aligned with over the long term. Also, investments come from the scout fund rather than you. I find it confusing and I feel it would weaken my personal brand. Lastly, the capital you can deploy is limited.
Very quickly, Ilan and I began to discuss with Sunil at Angel List, who pitched us the concept of the Rolling Fund. The concept was still in its early days, but we really liked the idea. Angel List really liked also our idea of creating a pre-seed investment vehicle dedicated to European entrepreneurs already based in the US. They soon proposed to us to be part of their Rolling Fund Early Access Program, and I would like to thank them for that. Without their support and this new fund model, I don't think Diaspora Ventures would have seen the light of day... We basically managed to set up our rolling Fund and start investing in just ten weeks! After my experience with The Refiners, I couldn't believe it myself.
So, what's different about Rolling Funds?
It is a new type of investment vehicle that allows its managers to share their deal flow with fund investors (LPs) on a quarterly subscription basis while netting carried interest over a multi-year period. More info here.
Basically, instead of raising a unique investment vehicle which usually requires months (or years), a rolling fund is structured as a series of unlimited quarterly funds. This allows fund managers to start investing much more rapidly, not having to rack up tens of millions of dollars before getting started. At the end of each quarterly investment period, a new fund is automatically set up on substantially the same terms, for as long as the rolling Fund continues to operate. Previous investors can continue participating, but the most exciting part is that new investors can hop in. With Diaspora Ventures, we started with just $2m initial commitment. After only two months of operations, we received $1m of additional commitment from new investors that will join Diaspora Ventures next quarter. Of course, as an investor, you only participate in the deals of the quarterly funds you have subscribed to, so new LPs joining don't come into existing deals.
If a fund doesn't deploy all its capital in a given quarter, the remaining capital balance is automatically rolled into the next quarterly Fund as additional capital from the Fund's currently-participating subscribers. LPs receive an equal contribution to the new quarterly Fund in addition to their subscribed-for capital contribution.
This rolling model wouldn't be possible without software, and that's the genius of Angel List. They have built both a technical and operational online platform to support the management of those rolling funds, think Fund as a Service — this infrastructure includes:
Fund management and accounting requirements…
Legal documents and regulatory filings
Bank accounts and special purpose vehicles (SPVs)
Fund pages and marketing documents
Tax reporting and Schedule K-1 forms
Investor management dashboards…
Fund subscription management
Subscription status and auto-renew
Minimum term commitments
Portfolio management software…
Investment and company tracking
IRR and other performance calculations
The software removes all the back office and middle office hurdles you have when you manage a traditional fund:
Legal set up fees and regulatory filings?
With The Refiners, it cost us +$80k to set up our Fund if I remember correctly.
Tax reporting and K-1?
OMG, that was painful and expensive. We had to contract with an external company to handle it ($40k per year).
With a traditional fund, it's your job to collect fund subscriptions and make sure each of your LP respected their initial commitments on time. Here subscriptions are automatically managed, and LPs can make their new subscriptions directly from the platform.
This is something we had to manage ourselves too. With Angel List, we just need to send them an email with the terms we agreed on with the founders. They review the deal for us and make the investment on our behalf. Done.
It takes a lot of time to collect and consolidate all your portfolio information. Here startups are automatically asked to report their data on the Angel List platform. Valuation and performance are then automatically calculated, and investors can check their individual ROI online through a personalized dashboard.
Beyond the simplified management of the Fund's back office and middle office, I think that the most interesting aspect of rolling funds is that it allows operators like us to concentrate on our real added value, i.e. making deals.
As entrepreneur-investors, Ilan and I get access to very early-stage companies, especially the ones led by french entrepreneurs in the US. Sometimes we get to know them even before they get incorporated. Our track record as repeat founders, business angels, and influencers make us more than just "investors". I have a feeling that seed-stage startup founders are looking for this kind of profile as they are more likely to help them both operationally and emotionally. This is even more true for European founders who in addition to experience are also looking for partners who understand their culture and who can help them overcome the natural challenges they will face when it comes to developing your company in the US. As Phin Barnes of First Round Capital says "Capital is a commodity, especially in this market. What you're saying with a term sheet is that you think the founder's equity is worth more than your dollars." That means investors have to close the value gap with sweat."
Like my friend Marvin mentioned in a recent post, the fact is most founders would prefer to take $$ from other founders or people who have good relevant operator experience. Harry Hurst on Twitter: "Early-stage founders want solo capitalists with cult Twitter followings on their cap table the same way DTC non-venture backed companies want celebrities on their cap table. Brand Distribution Network Amplification @jmj, @briannekimmel, @rrhoover you're like Cardi VC"
I know a lot of people like us (CEOs or Execs) who will be fantastic operator angels but who don't have enough capital or can't commit full-time to manage alone a traditional fund. I think that Rolling Funds is the perfect answer to them as a better way to raise capital and invest money. I can imagine an explosion of such vehicles run by active operators like us soon. I think this is also a fantastic opportunity to improve fund manager diversity. Wouldn't it be great if women and people of color leverage this opportunity and their communities to create their Fund? I feel like we need more of this. If we have to wait for the traditional funds to do the work themselves and recruit a broader range of investor profiles, I think we can expect a long time. I decided to launch my Fund 4 years ago because I knew I didn't have the Ivy-league pedigree and the personal network to join an established firm. Here I am today tho!
Rolling funds are also a fantastic opportunity capable of emerging a new generation of LPs. Micro-LPs. The minimum quarterly subscription for an investor can be as low as $1,000 per quarter. More typically, this minimum quarterly subscription ranges from $6,250 per quarter ($25,000 per year) to $25,000 per quarter or more. At Diaspora, we set our minimum quarterly contribution to $12,500 ($50,000 per year). This lowers the barrier of entry for individual investors, and we are seeing more and more people interested in participating because of this. This is excellent news; it will increase dollars invested into VC, and by extension, in the startups. Rolling funds are an easy way to invest in startups and access more new deal flow. In our case, we have committed to only investing through our rolling Fund, so investing in Diaspora Ventures is a fantastic way to roll up and capture Ilan, and I deal flow in a single investment. Also, we are limiting our investments to pre-seed and seed deals, and we will perk our pro-rata rights to our best investors for follow-on investments. Looking at our first list of LPs, we have both individuals (mainly CEOs and Execs) looking for diversification, but also Venture Firms interested in our portfolio for Series A investments (special mention here to Kima and Breega, more to join soon).
For founders, as we said earlier, rolling funds can add a lot of value beyond the money they provide as they are often started by founders, for founders, and with "founder-friendly" terms. Another exciting aspect is the fact that I am pretty sure we will see rolling funds set up to address specific niches or verticals. This is precisely the case with Diaspora Ventures. We are mainly focusing on the next generation of french entrepreneurs building tech companies in the US. We are convinced that France is full of talented and ambitious entrepreneurs and is home to some of the best engineers and product designers in the world. In the meantime, we have realized that most of the time, they do not have the opportunity to expand beyond their borders. Because they don't have access to the right funding, talent pool, playbooks, or network. French VCs, mainly based in Paris can't help them with their US strategy, and I don't know any US VCs pursuing this opportunity specifically. Rolling funds allow addressing those niche targets leading to an unparalleled fit between investors and the founders.
With hundreds of new rolling funds popping up in the coming years, the early-stage investing landscape might shift in the long-term. I don't think they will disrupt institutional venture funds investing in Series A onwards or the limited partners that back those funds but, the proliferation of micro-VCs backed by micro-LPs more seed-startups will receive funding. This might also push traditional VCs downstream towards later-stage deals. This is kind of the reverse of what we are seeing right now as more of them are trying to move upstream most of the time pathetically, to be honest. If I were them, I would instead propose their associates with strong personal brands to start their rolling funds. It might also be an excellent way to retain them and nurture their career-paths as they know they won't be offered a partner role anytime soon—just my two-cents.
As you may have understood, Ilan and I are big believers in Rolling Funds. It's like the "Passion Economy" has come to VC. If you are a startup founder or an investor, you should be excited too. Of course, this is just getting started, and a lot of questions remain unanswered. Ali Hamed raised interesting ones in a recent post here, but overall I feel the impact on the venture industry will be positive. Rolling funds are, in fact, only the continuity of a movement that started several years ago, as Nikhil Trivedi explains:
"Over the last couple of years, there's been an increase in individuals investing not just at the earliest stages of companies, but at Series A and beyond. These individuals aren't just investing their own capital. They're raising dedicated funds and special purpose vehicles (SPVs) from traditional limited partners (LPs). And they aren't just participating in financings alongside venture firms. These individuals are often competing against venture firms for the right to lead rounds, and signing term sheets before the companies get to pitch the traditional venture partnerships. Most importantly, founders are choosing to work with them, in some cases in lieu of partnering with firms. The importance of an individual's brand has been steadily increasing in venture capital for quite some time. Founders are more often than not picking an individual partner who they want to work in a financing round, based on the relationship built with them, and based on their brand and expertise, instead of the firms. So it's a logical next step that the firm is the individual, and the brand is the individual, which is the case with the solo capitalists."
Ilan and I will not fail to share our experience as managers of a rolling fund. In the meantime, do not hesitate to send us your questions if you want to find out more or if you are interested in setting up your Rolling Fund.
That's all folks for now. Let's make deals now!