The Rise of Emerging Managers in Venture Capital: A Shift Towards Individual Syndicate Pools
As a venture capitalist based in Los Angeles, I've witnessed firsthand the evolving landscape of early-stage investing. One trend that I believe will shape the future of venture capital is the rise of emerging managers operating on a smaller scale, focusing on individual syndicate pools for specific deals. This shift is driven by several factors, including the need for specialized expertise, the desire for more flexible investment structures, and the increasing importance of network effects in deal sourcing and evaluation.
One of the primary reasons behind the emergence of smaller-scale managers is the growing complexity of the startup ecosystem. As technology continues to advance rapidly, startups are exploring new and innovative business models that require deep domain expertise to understand and evaluate effectively. By focusing on specific niches or industries, emerging managers can develop a deep understanding of the market landscape, enabling them to identify promising investment opportunities that larger, more diversified funds might overlook.
Tech Coast Angels
During my time as a technology analyst at Tech Coast Angels (TCA) in 2013-2014, I had the privilege of witnessing the largest angel network in Southern California in motion. TCA was a vibrant community of accredited investors, entrepreneurs, and industry experts, all united by a passion for technology and innovation. My role as a technology analyst involved evaluating early-stage technology companies seeking funding and providing insights to help guide investment decisions.
One of the most valuable lessons I learned during my time at TCA was the importance of having smart, savvy investment directors who are close to the technologies involved. Accredited investors, who are individuals or entities that meet certain income or net worth requirements, often rely on these directors to help them navigate the complex and rapidly evolving landscape of early-stage technology investing.
Accredited investors are typically looking for opportunities to invest in innovative technologies that have the potential for high growth and returns. However, identifying these opportunities requires a deep understanding of the market, the technology, and the competitive landscape. This is where smart, savvy investment directors play a crucial role.
These directors are often industry experts or entrepreneurs themselves, with firsthand experience in building and scaling technology companies. They have a keen eye for spotting promising technologies and the ability to assess the team behind the technology, which is often a key factor in determining a company's success.
Furthermore, these directors are able to leverage their networks to provide additional value to investors. They can help connect portfolio companies with strategic partners, customers, and other investors, which can be instrumental in helping a company grow and succeed.
My experience at TCA taught me that accredited investors are not just looking for financial returns; they are also looking for opportunities to support innovative technologies and talented entrepreneurs. They want to invest in companies that have the potential to make a positive impact on the world and to be part of their journey towards success.
As a technology analyst, I was able to play a small part in this process by identifying and evaluating promising technology companies. However, it was the smart, savvy investment directors at TCA who truly drove the investment decisions and who I believe are essential to the success of any angel network. Their knowledge, experience, and passion for technology are what sets them apart and what makes them invaluable to accredited investors seeking to make informed investment decisions in the technology space.
Fund Flexibility
Another key driver is the desire for more flexible investment structures. Traditional venture capital funds typically have fixed investment periods and fund sizes, which can limit their ability to pursue certain types of deals or adapt to changing market conditions. In contrast, emerging managers can tailor their investment approach to fit the needs of each deal, whether it's providing seed funding to help a promising idea get off the ground or participating in a later-stage round to help a company scale.
Additionally, the increasing importance of network effects in venture capital is driving the rise of individual syndicate pools. As the number of startups seeking funding continues to grow, access to high-quality deal flow has become increasingly competitive. By pooling their resources and expertise, emerging managers can leverage their networks to source and evaluate deals more effectively, increasing their chances of identifying the next big success story.
American vs European Waterfalls
AngelList syndicates have democratized access to early-stage investing, allowing accredited investors to pool their resources and invest in startups alongside experienced lead investors. However, the use of American-style waterfalls in these syndicates, where returns are distributed on a per-deal basis rather than collectively, can lead to a number of issues that may ultimately harm investors.
One of the main concerns with American-style waterfalls is that they incentivize syndicate leads to pursue the most aggressive deals possible, regardless of the risk involved. Since returns are distributed on a per-deal basis, there is no high water mark that the syndicate lead must meet before the collective dollars must be returned. This can lead to a "heads I win, tails you lose" scenario, where syndicate leads are incentivized to swing for the fences in the hopes of landing a home run deal, even if it means taking on excessive risk.
Another issue is that American-style waterfalls can create a misalignment of incentives between syndicate leads and investors. Syndicate leads may prioritize deals that offer the potential for quick and large returns, even if they are not the best long-term investments for the syndicate as a whole. This can lead to a lack of diversification in the syndicate's portfolio and increase the overall risk profile of the investments.
Additionally, the lack of a high water mark in American-style waterfalls means that investors may be exposed to significant losses if a syndicate lead fails to deliver on their promised returns. Unlike European-style waterfalls, where returns are distributed collectively and a high water mark ensures that investors do not lose money unless the syndicate as a whole is profitable, American-style waterfalls offer little protection for investors in the event of a bad deal.
In conclusion, while AngelList syndicates have opened up new opportunities for accredited investors to participate in early-stage investing, the use of American-style waterfalls can introduce significant risks. Syndicate leads may be incentivized to pursue aggressive deals with little regard for the overall risk profile of the syndicate, leading to potential losses for investors. As such, investors should carefully consider the structure of any syndicate they are considering joining and ensure that their interests are aligned with those of the syndicate lead before committing their capital.
The future of venture capital will likely see more emerging managers operating on a smaller scale, focusing on individual syndicate pools for specific deals. This shift is driven by the need for specialized expertise, the desire for more flexible investment structures, and the increasing importance of network effects in deal sourcing and evaluation. By embracing this new model, emerging managers can position themselves for success in an increasingly complex and competitive market.