Private markets are evolving; the dominance of the ten-year fund is making way for capital deployed by more flexible discretionary vehicles with better terms.
Good article. I think something to watch is the rise of small/medium hybrid FoFs who will professionalize the co-invest. Hunter Walk recently posted reasons that funds under $100m shouldn't bother investing pro-rata. He is absolutely right. Data from AngelList and talks given by Abe Othman over the last couple/few years has pointed to this inconvenient fact. Look for Abe's talk comparing first check only versus pro-rata always strategies via Monte Carlo simulation. There is a nuance in their data.
The hybrids and others who catch on will realize LPs who invest broadly across the best small GPs will have a large opportunity set with which to pick into follow-on. As you say,the large firms will battle tooth and nail to cut back pro-rata rights in order to gobble allocations for themselves, but the best small GPs will retain the right because of the founder relationships they have built. These LPs are looking at these portfolios and building a view early so that their minds are better prepared when the time comes.
Avoiding pro-rata decisions avoids the agency issues that GPs face when they do follow on and allows them to focus on making first check investments only. By extension this builds a better opportunity set for their LPs. I see this kind of strategy as a counterpositioning for those who lack access to the best series A/B investors. It's a feature of this new cycle and with the rise of a new generation of GPs However, these LPs need to stay smallish in order to be nimble.
There's nuance to both, for sure. Walk's point broadly mirrors what I've written before about the importance of getting enough 'shots on goal' over holding capital for reserves.
He concludes that where you believe in a company more than the market, you should double-down to increase ownership and support them. So the implication here is that early-stage managers that invest in the really weird/frontier stuff will need to think more about reserves to get their portfolio companies over the line for subsequent rounds.
Othman had [never] doing pro-rata investments at the highest median performance, but [always] doing pro rata at the highest mean performance.
The implication is that doing pro-rata will yield slightly better long-term performance, but the greater variance may produce more short-term discomfort. Importantly, doing pro rata was mostly viewed as a negative for capital constrained managers where it would reduce their ability to make more initial investments (a problem that SPVs basically solve).
Large firms squeezing smaller firms on their pro rata allocation is definitely a concern. That said, the bigger threat is probably that they are increasingly neglecting the novel/non-consensus early-stage categories to focus on dominating hot categories. This is where the early-stage market may have to become more flexible, and better at forming capital through broader networks with a greater number of small contributors.
The question of pro-rata yes/no is also separate to the question of whether you do pro-rata from a fund or do it via an SPV (with some contribuition from the fund). So the agency issues remain, without some kind of rules-based approach.
e.g.
- The investor will do their pro-rata if they believe the investment makes sense (Walk's 'net new' framing) - with as much filled via SPV as possible (with >2% GP commit).
- The investor will do their best to help assemble the rest of the round, bringing in other collaborative GPs.
- It remains a soft commit until the round comes together. If the round fails then it's either a small bridge SAFE from the fund or nothing.
Good article. I think something to watch is the rise of small/medium hybrid FoFs who will professionalize the co-invest. Hunter Walk recently posted reasons that funds under $100m shouldn't bother investing pro-rata. He is absolutely right. Data from AngelList and talks given by Abe Othman over the last couple/few years has pointed to this inconvenient fact. Look for Abe's talk comparing first check only versus pro-rata always strategies via Monte Carlo simulation. There is a nuance in their data.
The hybrids and others who catch on will realize LPs who invest broadly across the best small GPs will have a large opportunity set with which to pick into follow-on. As you say,the large firms will battle tooth and nail to cut back pro-rata rights in order to gobble allocations for themselves, but the best small GPs will retain the right because of the founder relationships they have built. These LPs are looking at these portfolios and building a view early so that their minds are better prepared when the time comes.
Avoiding pro-rata decisions avoids the agency issues that GPs face when they do follow on and allows them to focus on making first check investments only. By extension this builds a better opportunity set for their LPs. I see this kind of strategy as a counterpositioning for those who lack access to the best series A/B investors. It's a feature of this new cycle and with the rise of a new generation of GPs However, these LPs need to stay smallish in order to be nimble.
Agreed re the coinvest - I know a bunch of ppl working on ideas in that space
There's nuance to both, for sure. Walk's point broadly mirrors what I've written before about the importance of getting enough 'shots on goal' over holding capital for reserves.
He concludes that where you believe in a company more than the market, you should double-down to increase ownership and support them. So the implication here is that early-stage managers that invest in the really weird/frontier stuff will need to think more about reserves to get their portfolio companies over the line for subsequent rounds.
Othman had [never] doing pro-rata investments at the highest median performance, but [always] doing pro rata at the highest mean performance.
The implication is that doing pro-rata will yield slightly better long-term performance, but the greater variance may produce more short-term discomfort. Importantly, doing pro rata was mostly viewed as a negative for capital constrained managers where it would reduce their ability to make more initial investments (a problem that SPVs basically solve).
Large firms squeezing smaller firms on their pro rata allocation is definitely a concern. That said, the bigger threat is probably that they are increasingly neglecting the novel/non-consensus early-stage categories to focus on dominating hot categories. This is where the early-stage market may have to become more flexible, and better at forming capital through broader networks with a greater number of small contributors.
The question of pro-rata yes/no is also separate to the question of whether you do pro-rata from a fund or do it via an SPV (with some contribuition from the fund). So the agency issues remain, without some kind of rules-based approach.
e.g.
- The investor will do their pro-rata if they believe the investment makes sense (Walk's 'net new' framing) - with as much filled via SPV as possible (with >2% GP commit).
- The investor will do their best to help assemble the rest of the round, bringing in other collaborative GPs.
- It remains a soft commit until the round comes together. If the round fails then it's either a small bridge SAFE from the fund or nothing.