Managing through the crisis - LP tips for GPs

Our friends at Top Tier Capital Partners, a world class fund-of-funds investor (aka an "LP"), recently threw together an interesting podcast on the state of the world as seen through the lens of a fund investor.

I jotted down some notes focused on specific insights that should be helpful for Venture Fund Managers (aka "GPs"). It was a great way to gauge the temperature on the LP side and some of the takeaways surprised me.

So let's talk about managing through the crisis as a fund manager, easing ourselves in with a positive macro observation: the best vintages in history were built in crisis, and (even if we assume exits delayed by 2-3 years), this is a great time to be in VC. Let's all be grateful fo that. Staying the course will be challenging, but there is an opportunity to build something special here.

If you're raising (more on this later), this is also a great time to build relationships - LPs have time! You will also be able to meet the full investment teams which NEVER happens due to travel etc. But beware, unless you have a prior relationship, you're unlikely to get over the line - think of this period as an opportunity for building pipeline and establish credibility, but don't expect to close much remotely.

Over-communicate with your LPs

LP right now are working HARD to assess portfolios. They have less access to primary information than we do and are trying to make sense of this crisis and be prepared just as much as we are. Specifically, LPs need to:

• understand risks to performance & get detailed guidance on downside
• precisely budget capital calls
• get predictions on liquidity if possible

Beyond that, company level insights into how the markets are being affected in various verticals are helpful to cross-reference across portfolios and build a complete picture. This is not a time to be sending one line updates on the value of their capital accounts if you want to be a great partner to them.

Traditionally most of us have been loathe to over-communicate on stuff we just don't know or can't predict, but these aren't normal times. Above all, avoid surprises and be super transparent about what's hard... LPs will understand!

Prioritise Liquidity

Even large LPs may need liquidity right now; pushing distributions down to investors is helpful to *everyone*. Liquidity is at a massive premium and your investors will be thankful for it.

• Generate liquidity where you can. Of course you don't want to sell too early but don't optimize for the last 0.1X of performance either.
• Don't hold public stocks. That's not what you are paid to do in normal times and it's certainly not the case now, especially if Mr Market is as off course as I think he is. Do Distributions-In-Kind if you need to and let your LPs decide.
• Consider foregoing recycling (typically 20%) in favour of liquidity. Don't hold on to cash.

Re-ups in your next fund may depend on distributions as LPs may need to re-use the cash themselves.

Reach out and understand the health of your LP base.

If you haven't done so already, go find out how your LPs have been affected. Is the crisis impacting their overall allocation to VC, are going forward commitments on the current fund at risk? What about your next fund, how realistic is it that they come in and when?

Have empathy and understand each situation, as each will be different.

• Example 1 - Sovereign Wealth fund in the Middle East, not just impacted by CV19 but also by the massive drop in oil prices.
• Example 2 - endowments may suffer from the denominator effect (their VC positions don't get market down much and so mechanically , massive volatility in public market and ongoing cash-flow obligations.

Secondaries are heating up.

Some LPs looking to sell all or part of what they consider non-core commitments (25% or less funded) to release themselves from future obligations. They may simply need to generate cash at all costs.

Some are looking to get out of clear non go-forward positions, which means your fund is being culled. I'd rather know than not know.

LPs are also selling out older, stable TVPI positions where they feel value has crystallized or upside is now limited.

The good news is that secondary sales are not representative of an overall negative LP view on venture - in fact, most LPs are fully recognising the opportunity and looking to double down in the best and generate or release liquidity to invest more!

VC fund formation is still surprisingly brisk.

"Deals that make sense, still make sense". Funds are getting raised.

Premier sponsors without "wants" (no team changes, still hungry) are just fine and a number of them accelerated fundraising.

Beyond that, firms taking advantage of the crisis have clear traction. I was hoping to hear about firms with amazing insights into the future but no. We're talking about:

• Value Buyers who are looking for strong companies handicapped by current market conditions and severely depressed valuations
• Fallen Angel investors - especially those funds that have leeway to invest in public markets and can use their unique insights to find good buys the market has oversold.

Basically nimble "special situation investors" akin to the distressed credit funds currently making a killing. Not my game but I get the thesis.

In a nutshell, and just like for startups, the world is splitting into the "haves" and "have-nots". Lean times ahead expected for emerging managers for sure, except for some "hot" new managers not burdened by existing portfolios. Overall it's going to be really tough to get attention and get on the list, as expected...

Opportunity Funds are attractive

Those with strong portfolio are seeing clear opportunities to "double down on the winners" at attractive prices. LPs like this given shorter expected time to exit and lower loss ratios.

The specific advice provided by Eric Fitzgerald here was as follows:

• You need at least 8-10 positions in the fund to avoid over-concentration
• Don't take your LPs for a ride -- these should be no fees or low fees on invested only, perhaps covering only the running costs
• 10% carry is OK, more is a discussion
• Generally keep the fund size proportional to original fund (e.g. 50%). There are going to be some natural exceptions here such as seed fund with amazing portfolio and a "no reserve" strategy.
• Make sure you clear conflicts. Should the main fund "feed first" etc (great image ;-)).

It was noted that not all managers do that - higher fees and carry are still common - but hey, you do you :-)

Fund Finance is tightening a little.

Fund finance deals are still getting done but at a slower pace; lenders in particular spend more time doing deep LP diligence. Currently GPs are not seen to be hoarding cash and the data indicates there are no LP defaults despite some rumours. Drawdowns are not increasing much, currently +5%. Be aware though - bankers are coming at you for more money, negotiating floors and pushing higher rates.