How to Evaluate an Emerging Fund Manager

Criteria and Best Practices Limited Partners (should) use to evaluate Emerging or First-Time Fund Managers as high-risk, high-return Opportunities.

(Photo by Noelle Otto, Pexels)

This is the third article in a series discussing the topic of investments in young venture funds, raised and run by Emerging Fund Managers.

Here are the other articles in the series so far:
1. Embracing the Potential of Emerging Fund Managers
2. The Rise of Emerging Managers in Numbers

TLDR:

Emerging VC Funds are a high-risk, high-return investment. To mitigate this risk, Limited Partners must evaluate the fund and its manager(s); due to its “emerging” nature however, there is not a lot of tangible data on which to base an assessment. Drawing from an analogy with VC funds evaluating new ventures, in this article we explain how to use Soft Due Diligence principles to find out if emerging fund managers can deliver on their promise.

Emerging and First-Time Venture Capital (VC) Funds have the potential to be a valuable addition to your investment portfolio. Their razor-sharp investment thesis, extremely committed managers, combined with an uncompromising focus on generating profitable returns are all good arguments to consider them in a balanced, risk-mitigated portfolio construction strategy.

Managing a high-risk, high-return Situation

Not only are these budding funds an exciting opportunity to access an asset class with potentially outstanding returns, the numbers seem to prove that Emerging and First-Time Funds’ success is not necessarily down to beginner’s luck: Emerging Funds have been consistently present in Venture Capital’s top-5 performers over a period of 17 years¹ and First Time Funds almost systematically outperform funds of established managers.²

High returns, however, do not come without high risk. This is true in Venture Capital in general, and even more so when VC funds invest in early-stage ventures. Only a few startup companies in a VC’s portfolio will generate the value needed to allow General Partners (GPs) to return capital and substantial profit to their Limited Partners (LPs).

When LPs invest in Emerging Funds, there is an added layer of risk involved: Emerging and First-Time Funds most of the time invest in risky pre-seed or seed stage ventures, but on top of that they are considered risky businesses themselves, because of their lack of maturity and track-record.

Emerging Funds are just Startups

From an entrepreneurial point of view, Emerging and even more so First-Time Funds are nothing but startup businesses themselves.

A fund is a business implementing a two-sided business model, with LPs as one kind of client on one side and Startup Ventures as another kind of client on the other.

Prosaically speaking, VCs are intermediaries facilitating investments from said LPs into said Startup Ventures, adding value through their ability to select and manage relationships and provide a risk-mitigation mechanism through their fund structure.

This being the fundamentals of their value proposition, VCs also have to distinguish themselves from their peers in order to attract LP’s investments. This has never been more relevant in the last decade than today in 2023, where LP’s commitments to VC funds are historically low.

Mature VC firms have a history and track-record to give their investors some assurance over their ability to manage the capitals entrusted to them, and they can demonstrate a level of returns from past funds that LPs will expect à minima to receive from the money that they are about to commit to a fund.

But even mature VCs need an “edge” that makes LPs choose them over their competition.

Going back to entrepreneurial terminology, VCs need to have a focussed Value Proposition, a holistic and consistent concept that involves a deep understanding of clients’ needs on the one hand, and a product and service as an exact response on the other, solving the problem generating the need in an effective and unique way (see Alexander Osterwalder’s work here for example).

Building on Osterwalder’s work, Ash Maurya (Leanstack) adds the concept of “secret sauce” to the recipe: for a business model to be successful, there must be something in the mix that enhances its uniqueness, and makes it hard to copy. This can be either linked to the product or service (e.g. a patent, or a skill or technique that is hard to reproduce) or to the entrepreneurial team (e.g. proprietary knowledge or an exceptional network).

When evaluating an Emerging Venture, i.e. a Startup Company, which by definition has no track-record and financial history to offer, VCs need to deploy a multi-faceted Due Diligence strategy in order to assess the chances of success of such a precocious business model and the likelihood of a team to execute on it.

Emerging Fund Due Diligence

Looking at Emerging and First-Time Funds through the lens of this Startup analogy allows us to draw from established Due Diligence strategies and processes in order to evaluate the likelihood of an Emerging Manager to execute her or his business model.

To be a little more precise on the analogy, we would look at Emerging and First-Time Funds in the same way as VCs would look at a Startup Venture at pre-seed/seed stage, meaning there should be a consistent business model hypothesis, problem/solution fit and a validated technology or product/service concept.

At this stage, tangible information is scarce, and traditional Due Diligence strategies and processes (e.g. financial, operational, organisational) are often of little help when there is almost nothing to evaluate yet.

This is where the power of Soft Due Diligence resides: instead of trying to come to a seemingly rational investment decision by extrapolating from the few facts a venture can provide at that stage, Soft Due Diligence focusses on the ability and capability of the protagonists (i.e. founders) to enact a yet mostly unwritten story (i.e. business model). Soft Due Diligence is not that much about asking “What?”, but rather “How?” or “Why?”.

Two Kinds of Success

In our academic research on Soft Due Diligence, we found that VCs evaluate an Investment Opportunity according to a twofold conception of success: Business Success and Investment Success.

For a VC investment to succeed, the portfolio company has to be successful, sell to customers, generate income, cover its costs and engender a profit. This is only possible if the founding team is capable of implementing and executing their proposed business model, generating value for the company’s shareholders on the way. This is Business Success.

Business Success alone is not enough for an Opportunity to be a successful one: VCs need to be able to return a substantial profit to their investors, on top of the initial capital. For this to happen, a portfolio venture has to mature in a way that makes it attractive for a future investor or buyer, in order to allow the VC Fund to “exit” through a liquidity event, for example by selling the shares detained by the fund with a profit.

VC funds are generally close-ended, most of the time limited to a 10 year period between the first investment and the mandatory restitution of capital and profits to the investors. Investments must happen relatively quickly at the beginning of this period, over 3 to 4 years, to give portfolio ventures the time to grow and allow for a timely divestment and liquidation of the fund.

Ten years may seem a long time, but the process from evaluating, investing, managing, and exiting a portfolio venture is far from a long quiet river.

During that period VCs and founders must be able to work together to grow the Startup Venture into a (more) mature business. They do not need to be friends, but they need to be able to establish a collaborative atmosphere based on mutual respect and transparency that can endure difficult times and last for years.

To succeed in going full circle with all the ventures in the fund, founders and VCs need to have total alignment on their objectives: not all founders are ready to manage their business in a way that prioritises fast growth, and many of them experience reticence to step aside if needed, and let a professional manager guide the business towards a timely exit.

Business Success and Investment Success both have to happen for an Investment Opportunity to result in a substantial return. When the target is an early-stage venture, most of the underlying factors for success or failure are of a “soft” nature, related to the capabilities and attitudes of the people involved with the business.

Searching for Success in the LP-GP Partnership

The Business/Investment Success model is very much transferable to the relationship between Limited Partners and the General Partners and the Venture Capital Firm. Limited Partners need the VC firm to achieve Business Success - find and execute profitable deals - while at the same time ensuring Investment Success - building and maintaining an alignment of values and objectives over the long time of the investment period.

In the following paragraphs we are going to give an overview over the main topics that are relevant to evaluate this partnership from both success perspectives:

A. LP-GP Hard Fit (Business Success)

To make sure an allocation of capital in a VC fund fits your strategic goals and investment objectives as a Limited Partner, a certain number of tangible factors must align. However tangible these might be in theory, there will always be a soft factor to them, in particular when considering an investment in an Emerging Fund.

1. Investment Terms

The first thing you are obviously going to check, and the easiest information to get hold of, are the fund’s investment terms and conditions. Very often fund and fee structures as well as fund governance principles are part of a first filter to ensure the basic parameters of the fund fit your investment strategy.

While certain restrictions and limitations will put a hard end to the evaluation, keep an open mind when it comes to fund characteristics where you are able to give yourself some room for flexibility. An unfavourable fee structure might be putting you off, but there could be other “softer” elements (see discussion below) that might justify it.

Questions to ask yourself:

• Do the fund terms and conditions match our investment goals and objectives?

• Are the terms and conditions compatible with restrictions and limitations we are subject to?

• What are the elements that raise concern, but could be outweighed by other factors?

2. Investment Thesis

The second element that should be very clearly communicated to you is the fund’s investment hypothesis. This must be at least a unique combination of industry focus, venture type and geography, together with an explanation of the thought process that allows the fund manager to argue that this is what is going to lead the fund to produce a substantial return for you as a Limited Partner.

Emerging Funds have the luxury - and in our opinion the obligation - to have a very sharp focus when it comes to their investment thesis. They are nimble, with a small team and hopefully loads of ambition and a healthy motivation to succeed. Far from being an obstacle for success, their small size allows them to be very radical in their decisions what to invest in and what not, and then stick to it.

Their strength is to be able to develop a very deep understanding of the kind of ventures they plan to invest in. Often, Emerging Managers bring with them some special industry knowledge, or they are very familiar with a particular region of the world or a demographic that provides a unique angle to their investment thesis. Many Emerging Funds also target emerging geographies, often closely related to the fund managers own origin. Them stemming from an underserved culture in terms of products and services might also give them privileged access to their community, to the benefit of the ventures they invest in.

For your further evaluation, keep the investment thesis in mind as the big picture into which the whole rest has to fit. Ask yourself if the thesis itself is coherent, unique and ambitious, and above all if it presents a very, very clear focus. Then, when you consider the other aspects of the investment opportunity, always check them against the big picture to understand if all the pieces of the puzzle fit together.

Questions to ask yourself:

• Does the investment thesis make sense? Is it comprehensive and coherent?

• Is it focussed enough to allow the fund to execute it with limited resources?

• Is it clear what falls in the scope of the thesis, and even clearer what not?

• Does the thesis have an “edge”, a character of uniqueness that distinguishes it from what we have seen elsewhere?

3. Fund Manager

Emerging Managers and even more so managers rising a First-Time Fund do not have the luxury of a solid track record showing the performance of their prior investments and the pertinence of their past investment decisions. But there are other ways to look at a prospective fund manager’s professional history to evaluate their ability to execute the investment thesis on the table.

Many Emerging Managers split off of more mature VC firms, and a look at the track record of their activity in a former position can provide good insights. Just as VCs do it with the founders of their prospective portfolio companies, you can ask them for references, and check them with a quick call.

Others might have built some relevant experience by other means, either by investing as Angel Investors themselves, or by participating in or by building Angel syndicates. Looking at how they went about that will give you some insights into their ability to build relationships with ventures and partnerships with other investors, both crucial skills for successful fund management. Their own investment portfolio can give you a “preview” of what their future investments might look like.

But there are other, not directly investment related experiences that should help them give a favourable impression: engagement in other startup related contexts, like Incubators, Startup Studios and Accelerators in various roles allowed many Emerging Managers to hone their evaluation skills and gain a deep understanding for early-stage entrepreneurship. As an added benefit, the continued relationship with the startup ecosystem provides them with good access to new ventures and ensures a steady deal flow.

But professional history and experience is not everything, and even previous failure and lack of performance must not be a decisive criterion. After all, professional life is not necessarily a straight line. Many other “soft” factors can give you an indication about an Emerging Manager’s ability to raise and run a successful fund.

Questions to ask yourself:

• Where does the fund manager come from? What are professional (or even extra-professional) experiences and activities that enrich her or his profile?

• Keep an open mind: creating high quality deal-flow needs people who know how to create and maintain a network, and who are comfortable building constructive relationships. What are the elements in the fund manager’s profile that prefigure that?

• This is rarely a one person business, and even “single” fund managers need a support network around them to pick up where their knowledge and abilities end. What does the professional network of this particular fund manager look like?

• By whom is he supported? Who is on his team (close or extended) and what does his ecosystem look like?

4. Fund Team and Ecosystem

Venture Capital is a very gregarious industry where relationships matter. Be it inside a firm, amongst VCs, or with prospective or acquired venture founders. Everybody talks to everybody, few VCs expect (or can afford) to go alone, in particular emerging or first-time funds rarely take the lead.

As an LP, it is of extreme importance for you to understand how an Emerging Manager is surrounded, as the quality of the ecosystem and his engagement with it constitutes an essential asset.

Using the onion-skin model as an analogy, and starting from the inside, there is (hopefully) a team. VCs are notoriously victims of a wide range of biases, and working closely with a peer, being able to have a critical look on one’s basis for decision making and running decisions by a colleague before committing helps fighting those. For your evaluation, it is important to see the team as a whole, and to understand how the members of the team complement each other, across all stages of the Venture Capital Investment cycle.

Questions to ask yourself:

• Who is in charge of what?

• Is everybody doing what they know best? (i.e. fundraising, deal-flow, financial management, value-adding, …)

• Is this a team that has worked together previously? How did that go?

• Are there any competences missing from the team?

• How does the team composition fit the investment thesis?

• How do you feel about this team being able to execute on the investment thesis?

Continuing with the onion-skin model, look at the extended team of the firm. Non-permanent team members might play an important role in filling gaps in an Emerging Fund’s setup. Venture Partners, Advisors and even Mentors, former colleagues from a previous job in a VC firm or privileged relationships with high-quality industry experts or scientists might provide the experience that the core team of the fund lacks.

Questions to ask yourself:

• What does the fund’s ecosystem look like? Do the managers have access to experienced peers, to high-level industry experts?

• How does/do the fund manager(s) benefit from their network, and how do they integrate external expertise in their evaluation/decision-making/management activities?

• How does the fund’s ecosystem match the fund manager’s combined characteristics? How does it fit and to which degree does it support the investment thesis?

The outermost onion-skin layer would be the fund’s non-operational relationships, such as peers, organisations and other networks the fund managers have privileged access to.

Questions to ask yourself:

• Are the fund managers an active part of their larger ecosystem?

• How closely do they interact with peer VC funds? How good is their access to participate in investment rounds led by firms in their network?

• Do the fund managers engage with their own or adjacent professional organisations (i.e. VC networks, Angel Investors and Syndicates) and are they an active part in them?

• How about their engagement in the industry specific networks of the companies targeted by their investment thesis?

• Do they participate in startup-related events and engage with the wider startup ecosystem (i.e. incubators, accelerators, educational programmes)?

5. The Fund and Firm as an Organisation

Before, we said that Emerging Funds are nimble. By necessity first, probably, as the funds are relative small and management fees often not abundant. But Emerging Fund Managers know how to do more with less and make management fees go further. Just like startup founders, Emerging Managers must deploy creativity in maximising the impact of the money they can spend. Emerging Funds even more so than more mature funds have to be designed for performance.

For you as a Limited Partner, this is good news, because it looks like you are getting more for the fees you are paying: lean organisational structures and a focus on what is essential to achieve success should be aligned with what you expect.

But don’t take it for granted. Pay close attention to how the fund is set up, and how it intends to spend (or spends) the funds available for fund management and value-adding activities. And this goes in both directions: too much money for the wrong things, and not enough money for the right ones.

Venture Capital (surprisingly still) has an aura of “big bucks” and lavish “Wolf of Wall Street” lifestyle, which also attracts some of the wrong people amongst many honest people with the right ambitions. Give a six-figure sum every year to someone who feels that being a VC gives him a right to drive something like Jordan Belfort’s Lamborghini Countach, and you might realise after a while that your management fees are not adding value to whom you might have expected.

Humour aside, and this is very likely an exception, but you should still be well informed about the cost structure and financial roadmap of the VC firm you are going to work with for up to 10 or even 12 years.

More often than the cinematographic example cited above, you might encounter Emerging Fund Managers with a lot of good will and intentions, wanting to do a maximum for their portfolio companies, but lacking the organisational or financial means to do so. Also, with all the best of ambitions, keeping the motivation high over a decade or more without proper remuneration for themselves will prove difficult.

When looking at the fund’s organisational structure, keep in mind the investment thesis, value-adding ambitions and - of course - the fund’s expected number of investments.

Questions to ask yourself:

• Does the fund’s organisational setup match their ambitions? How “lean” is it?

• Does the fund’s cost structure (remuneration, travel, etc…) seem appropriate?

• How many portfolio companies will be assigned to each fund manager?

• How do the planned value-adding activities add up, and how is their organisation and implementation distributed among the fund managers?

• If not performed by the fund managers themselves, what does the platform support system look like? Who is part of it, what are the associated costs?

• Taken the direct and indirect cost structure of the fund into account, what does the remuneration of the fund managers look like? Is it fair, are incentives attractive enough to keep them motivated in the long term?

6. Fund Strategy

After closing the fund (ideally and more frequently already before) the fund managers run deal sourcing activities, fill the fund’s pipeline and evaluate prospective ventures before taking investment decisions. After the investment, portfolio companies benefit from VC’s networks and value-adding activities, helping them to grow, reach their milestones and generate value for their shareholders on the way.

For the fund’s success it is crucial to have a structured approach to managing the Venture Capital cycle. This starts with a position on how deals are sourced, how they are evaluated, how investment decisions are made, what portfolio companies can expect from their investor, how future funding rounds are managed and what the exit expectations should be.

All this should be a well defined, sound and consistent framework, capable of implementing the Investment Thesis through a series of strategic guidelines. It should be clear where the red lines are, and which aspects of the overall strategy allow for space and flexibility.

When it comes to Emerging Funds, these guidelines are most of the time nothing but a bunch of good intentions. However, as a consequence of the strong focus that Emerging Funds (should) have, the outline must be very clear and help you understand how the fund managers will implement this strong focus, and where they are willing to give themselves some slack.

Questions to ask yourself:

• What are the strategic guidelines at each stage of the Venture Capital Investment cycle? I.e. how are prospective ventures evaluated? What are the most important hard and soft criteria?

• Does the firm have a “playbook”? To which degree are these rules formalised?

• Does the firm implement an “agile” approach in their processes, e.g. are rules intentionally and systematically reviewed, in the light of successes and failure? Is there a process of organisational learning?

• What about agile retrospectives? Is there an ambition to systematically improve ways of working by examining what works well and what does not?

• Again: how well do the strategic guidelines fit with the overall investment hypothesis?

7. VC - Founder Relationship

The relationship between fund managers and the founders of their portfolio companies is bound to last many years. During that time, these founders have the task to work towards and ultimately reach the agreed milestones, a journey not exempt of difficulties.

For them, it is important to have the right investor at their side, where the “right” might take on a variety of shapes: more or less involvement, more or less support, more or less control. What matters to founders is to find resonance in their relationship with investors.

For this resonance to happen in a VC - founder relationship, expectations have to be clear and aligned: the venture has to prosper, value has to be created for shareholders, and returned to the investors through a liquidity event, an exit. Basing this relationship on transparency and trust, a constructive attitude and mutual respect from the onset is key.

The benefits of the right mix of hands-on/hands-off involvement and the right attitude towards the founders is manyfold: the fund is more attractive, especially to founders who know what they want and need, and this is the kind of founder you want in a fund. Negotiations between parties that work at eye-level tend to have a more sustainable outcome, and create the foundation for long lasting relationships. Getting used to hearing each-other out early on increases the chance of navigating choppy waters in this long working relationship where difficult times are bound to happen.

As a Limited Partner, you want to allocate your money to a fund that does everything to maximise the chances of a substantial return. Exploring the fund manager’s attitude towards relationships with their founders will give you a good picture of how well this attitude fits with them.

Let’s go back to our startup analogy: every startup business has to have extensive knowledge about their customers in order to serve their needs adequately and comprehensively. An emerging fund is no exception to this rule: founders are one of the two customer groups they serve, and knowing their founders, i.e. their particular customer segment, is key.

Here again, Emerging Managers should excel. Deep industry knowledge and proximity with founders either through their own entrepreneurial experience or their activity in the startup ecosystem often gives them the necessary empathy to know what is needed and how much of it is the right amount.

Questions to ask yourself:

• How would you describe the fund manager’s attitude towards founders, the quality of their interaction? Could it be qualified through attributes like trust, respect, transparency?

• How well do you think the fund managers understand the founder’s needs? Do they show empathy with the founders?

• How much importance do the fund managers place on the alignment with founders, in particular in regards to post-investment topics like management replacements, speed of execution, milestones and KPIs, nature and timing of potential exit opportunities?

• Does the nature and degree of fund manager’s involvement fit with a) their own investment thesis and strategy and b) with the founder’s needs (given the stage of the ventures, the industry, the geography, …)

B. LP-GP Soft Fit (Investment Success)

So far we have been examining aspects of the “hard” fit between LPs and GPs, relevant for the Emerging Fund Managers to achieve their Business Success. This involved anything that allows to assess the likelihood of a successful cycle of selecting, investing, managing, and exiting ventures in a way that returns a multiple of the allocated capital to the Limited Partners of the fund.

But for the Investment Opportunity to achieve overall success for Limited Partners, the LP - GP dyad is dependent on Investment Success, i.e. the construction and maintenance of a decades long relationship based on an alignment of objectives and values.

1. Purpose

Traditionally, Emerging Funds receive most of their funding from High Net Worth Individuals (HNWIs), Angel Investors or Family Offices. Much rarer are asset allocations by Institutional Investors (Banks, Insurance Companies, Pension Funds, Sovereign Wealth Funds) because of the high-risk profile and small ticket sizes inherent to Emerging Funds.

Investors in Emerging Funds frequently choose a fund because there is something in their own history or profile that resonates: for example former startup founders close to the industry the fund invests in or HNWIs from cultures that the fund targets with investments.

This emphasis on purpose is perhaps even stronger with Family Offices, whose objective is to preserve intergenerational wealth, and to create an instrument to care for future generations of the family. Many Family Offices originate from wealth generated in a family business, and an affinity to entrepreneurship is deeply ingrained in their investment activity.

Investing in Emerging Funds can be for many of those investors a way to reconnect with the roots of the wealth that they manage: Angel Investors giving back by providing funding but also support or Family Offices reconnecting with their entrepreneurial origins.

Emerging funds often focus on purposeful investments that have the capacity to resonate with the core values of their (potential) Limited Partners. They frequently occupy niches by financing ventures from underrepresented geographies and cater to underserved demographies. Their need to develop a strong focus, and to stand out amongst more mature or mainstream VC firms almost naturally takes them into territories where investments create environmental or social impact while demonstrating high standards in terms of governance (ESG).

For Limited Partners, Emerging Funds have the capacity to simultaneously respond to the intention or obligation to invest mindfully, while satisfying many ESG related requirements or constraints.

Questions to ask yourself:

• What are the fund’s (or the fund manager’s) core values and how do they express in the fund’s investment thesis? How do they relate to the values we stand for?

• What is the core purpose of the fund’s investment thesis? To which degree does it overlap with the way we want to allocate our capital?

• Which ESG related constraints and objectives will be fulfilled or impacted by an investment in this fund? How high is the quality of the reporting, and how easy will it be for us to process it?

2. Fund Manager(s)

This is perhaps the topic where Soft Due Diligence gains the most importance: investing in an Emerging Fund comes down to investing in an Emerging Manager (or a small team of Emerging Managers). Cue the startup analogy: investing in an early stage venture comes down to investing in a Founder (or a small team of founders). The situation is the same: very little tangible information and almost no historical data available for conducting an evaluation.

Just as VCs with founders, as a Limited Partner we can ask ourselves: Why in earth does this Emerging Manager want to raise a fund? What is his motivation for trading the option of a cushy corporate job (they could get without problems based on their experience) against long and tiresome hours of research for funding, dealing with stubborn founders and the agonising pressure of exiting everybody before the fund is supposed to be wound up?

The central question is “Why does she/he want to raise a fund?”.

And this is not about the Investment Thesis or the opportunity to generate value for their Limited Partners and themselves. It is about what it means for them to be raising a fund and then to be the person managing it. What is the deeper, intrinsic motivation?

The clue might be in the previous section, some fund managers want to make a difference, make the VC industry evolve, drive a particular type of innovation, restore some justice in capital allocations or generate environmental impact.

When evaluating this Emerging Manager, we have to examine this quest for purpose in the light of the investment thesis and the other elements influencing the Business Success of our investment. And then, confront that story with her/his higher purpose. Does this fit? Is there coherence between the role of the fund as a an investment vehicle and the role the fund plays in the life of the fund manager(s)?

A strong intrinsic motivation that is aligned with the fund’s purpose and Limited Partners’ interests is indeed a powerful combination. These fund managers are able to formulate and express a vision for what they are doing, and capable of generating the enthusiasm and momentum necessary to launch the fund lifecycle.

Questions to ask yourself:

• What is the purpose of this fund manager? Why is she/he doing this? A good question to ask in this context would also be “What else would you do, if you were not raising a fund? (or what would you do if you failed to raise this fund?)”

• What is the fund manager’s vision? Does she/he generate enthusiasm? How likely is it that they might motivate other investors to join the fund?

• What does this mean for my investment? Do I feel comfortable with the fund manager’s intrinsic motivation, or is it colliding with my objectives or my own investment thesis?

3. Fund Team

In the discussion above, we have seen that managing a fund is rarely a solo activity, whether that means that there is a management team or a strong support network.

The first, and often overlooked, team member is/are the fund manager(s) spouse(s). Unless she or he lives alone and in total independence, it is crucial that fund manager’s obtain the opt-in of their significant other, or even of their families.

Raising and running a VC fund is more than a 9-5 job and requires long hours, travel, worry, despair and a whole other range of strong emotions, some of them even positive ones. Being (or becoming) a GP is a project that impacts not only one’s individual life, but the lives of one’s whole family. A committed spouse is a powerful ally, a spouse kept in the illusion of a strict separation of the professional and private domain makes Darth Vader look like an angry kitten.

When it comes to the core operational team, we saw that its composition is central to providing the fund with the combined skillset to achieve Business Success, but the inner workings of the team will determine the Investment Success part of the Opportunity. And this team must be strong and solid, and capable of weathering the storms of a decades long collaboration.

As with any team, the collaboration of more than one individual invariably raises the question of leadership and management styles and qualities. In an Emerging Fund the team will likely be very small, but deficits in management capabilities and lack of leadership will even more directly impact the quality of their work, and their relationship with you as their Limited Partner.

Understanding the team and management culture, how flat or hierarchic (yes, in a 3-person team!) it is organised, how personal initiative and opinions are valued (or not), what is considered a success and how it is recognised and celebrated (or not), how failure and mistakes are tolerated (or not) and dealt with (or not, you got it), what the reaction to a crisis would look like; all these elements are going to impact the communication and touch-points you are going to have with the fund team.

Emerging Funds are supposed to be very focussed on success and on generating outstanding returns. At the same time they need to be able to take risks and to learn quickly from their mistakes. This can only happen in a work climate and team culture that fosters mutual trust and transparency, and where people feel safe enough to risk making mistakes.

This culture should not only stay contained inside the fund’s core team, but permeate all of the fund team’s relationships with stakeholders involved: the founders and venture teams downstream, and of course the Limited Partners upstream. Again: a sound and coherent way of working and communicating at all levels, internally and externally.

Questions to ask yourself:

• Is the fund manager’s professional and private situation aligned? Can I be sure that he is in it for the long run? Is there anything that could make him capitulate prematurely?

• Do I feel comfortable with the working style and culture of the core fund team? Does their way of working make it easy for me to interact with them?

• Is the fund team harnessing the power of their collective minds and skills? Or is it a one-man show with a couple of assistants?

• Is the team balanced? Where are gaps in the team’s composition and skillset?

• What does the team’s culture and management style mean for my investment? How does it impact communication?

2. The LP - GP Relationship

And high quality communication is central to the relationship that Limited Partners rightfully expect from fund managers.

In particular from Emerging Managers, LPs can expect careful attention to communication quality. Emerging Managers need to compensate their lack of track-record with excellent service, and often spend more time interacting with their LPs than managers of more mature funds.

Lack of experience and absence of routine might impact the communication in a negative way, but you want your Emerging Manager to be ready to admit mistakes and learn from them to avoid them in the future. This might seem a high price to pay, but in return - in addition to potentially outstanding returns - you might also get to work with people who are extremely proactive and eager to serve.

After all, an Emerging Manager’s goal is to graduate from the “emerging” status, and she or he can only achieve this by building a network of committed LPs ready to invest in fund n+1 and n+2. For you, this is an additional investment that might pay well later: Emerging Managers of today are the unicorn hunters of tomorrow who invested at seed stage. And you might just get the best seat at their highly coveted table.

When evaluating an Emerging Manager, pay attention to not only the content of the documentation and the reporting, but also to different aspects of quality. The information should be presented in a pleasant way and easy to consume. Producing attractive documents is in everyone’s reach these days, and you are entitled to a reading experience on par with the level of management fees you pay.

But even more important is the selection of information the fund managers provide: this should not be a mandatory chore to get rid of every quarter, but the fruit of a real ambition to inform you about what happens with the capital you committed to their fund. VCs expect prospective ventures to know their customer, and you can expect your Emerging VCs to know theirs.

Questions to ask yourself:

• Do I feel that these fund managers have empathy with Limited Partners? Do I have the impression that they understand my needs (and worries, concerns)? Is there resonance in the way we interact?

• How does the quality (in visual and content terms) of the documents I am provided fit with the perception I have of the fund?

• How is the quality of interaction between the fund and myself? Do I feel like a partner in a collaborative environment?

• Do I really want to commit interacting with this fund (manager) for the next 10 years?

How to go about the evaluation?

After this admittedly very long list of considerations, questions and reflexions on evaluating Emerging Managers and their funds, we would like to end with some recommendations on the evaluation process itself.

Evaluating an Emerging Fund is - to make it short - finding the answer to the question “What’s the story here?”. Finding the answer supposes piecing together the story from all kinds of information, gathered from the documentation and the conversations with the fund managers.

Soft Due Diligence - and most of the topics mentioned in this article would fall in this category - is not a process distinct from traditional Due Diligence, but rather an always present way of adding a layer of meaning to the information and facts collected. Where traditional Due Diligence answers the “What?” question, Soft Due Diligence more often attempts to give sense where we ask ourselves “How?” or “Why?”.

With Emerging Managers, there is not a lot of “What?, but loads of “How?” and “Why?”, which makes Soft Due Diligence a powerful and adequate tool for evaluation an Investment Opportunity with their funds.

Soft Due Diligence is performed all the time during the evaluation period, everywhere and at every opportunity. The nice thing with Venture Capital is that it is a highly social industry, and the opportunities to perform Soft Due Diligence are often very pleasant ones: besides official meetings and presentations, lots of business happens while having a drink or enjoying a meal. Do not get me wrong, this is real work and you have to focus to use the dinners, receptions and parties wisely to build the story and to fill the gaps in the narrative.

The best way to do this is to interact as much as possible with the fund manager(s). Ideally you should even find an opportunity to collaborate on something with them, to get a taste of how they behave when working.

Ask a lot of open questions (that make them talk by themselves), respect the 20/80 rule (talk 20% of the time and listen for the rest) and make your conversation partner(s) comfortable by listening actively and giving them space to elaborate on their thoughts. Pay attention to non-verbal clues, the intonation of their voice, the gestures, posture and facial expression while they talk, this might give you more information about what you asked than what they are saying.

This might sound like manipulation, but you are not trying to make them do anything against their free will. Your goal should always be to validate the assumption of a future fruitful and prosperous partnership.

Enjoy the ride, but respect the Emerging Managers. They are putting everything on the line for their fund and for you!

Our next article in the series might switch sides, and summarise best practices for the attention of Emerging Managers getting ready or finding themselves in the thick of the fundraising process.

Note: The content provided in this article is for informational purposes only and does not constitute financial or investment advice.

1. https://www.cambridgeassociates.com/insight/venture-capital-positively-disrupts-intergenerational-investing/

2. http://docs.preqin.com/reports/Preqin-Special-Report-Making-the-Case-for-First-Time-Funds-November-2016.pdf