October 24, 2023

Breaking The Inertia - Why Now Is The Time For A Fund Of Funds

Happy Tuesday, friends. I’ve been thinking a lot about the evolution of our industry, and the ingredients necessary to push it forward at a faster pace. I think we need a few things including (a) an association that organizes itself around our collective interest; (b) industry standards; and (c) the availability of a sustainable institutional capital source.

Today, I want to talk about (c): the availability of a sustainable and institutional capital source. First, why is this important? Alternative capital (I still hate that term) as an asset class will struggle to achieve critical mass or sustainability until capital is available at a quantity sufficient to support the growth of early movers like Tyler Tringas at Calm Fund, and Jonathan Bragdon at Capacity Capital. These early movers are delivering returns to their investors, and need larger, institutional investors in order to scale their funds, impact and reach. Without it, they will struggle to grow to meaningful scale, and LPs will miss out on a new asset class as it emerges.

Here’s a great thread by Tyler at Calm Fund that shares his experience raising institutional capital. Tyler shares more details on this in our upcoming RBFN podcast episode, which we’ll release on Oct. 31st.

To get ahead of the challenge Tyler shares, the Kauffman Foundation launched the Capital Access Lab in 2020. That was a very important first step. It was a visionary, courageous, and bold move toward building an asset class and catalyzing the institutional support to capitalize innovative GPs. Now the industry needs another spark, and with returns rolling in, and with alternative emerging managers needing larger pools of capital to continue their growth, it’s time for more LPs to open their aperture.

A friend recently asked me if it was time for an alternative capital fund of funds to carry on what Kauffman started. I wasn’t sure because I wondered whether there was sufficient traction in the market to really justify a run at institutions.

I’ve talked to about a dozen alternative managers since then, and I don’t wonder anymore. They all face the same challenge: they are delivering high returns, but they can’t scale from raising funds from high net worth individuals. They need institutional capital, or they will be raising small funds forever…and small fund economics are really, really hard to make work. They are basically prohibitive, actually (alternatives to the standard fund economic model should be in play here, too, by the way!).

If you’re on track to deliver better returns than a VC, and you can’t raise from institutions because your deal structure is different from the normal seed or Series A or whatever-series VC structure, then I think we have a capital markets problem. The capital markets are not evolving fast enough.

Institutions like CIM solve this for alternative credit providers, but there are very few (if any at all) institutional providers of capital for alternative equity investors. Where is the CIM of the equity side that would allocate substantial capital to, for example, Calm Fund?

As Tyler points out, anything innovative about your deployment model will likely make it difficult for institutional LPs to get excited. Tessa Flippin at Capitalize VC shared on our podcast episode that when institutional LPs say they want a GP to “differentiate”, she learned that they really mean they want the GP to have a unique fund size, portfolio construction approach, and thesis. But they don’t want innovative investment structures. And at Novel we quickly learned when we were raising Fund I that because our deployment model was different, we absolutely needed to keep our fund structure as vanilla as possible. That’s one reason we decided to shift models and raised a credit facility; we knew we couldn’t scale as quickly as we wanted if we were banging our heads against the wall trying to convince institutional LPs to invest. I could go on and on, but you get the gist, and you’re probably living it.

That’s why I think it is indeed time to collaborate on reigniting the spark that Kauffman started. I think we can convene courageous institutions and explore a fund of funds strategy that aggregates capital from those institutions ready to allocate to something proven but new, different but profitable. I think it’s time. I know several people who are ready to work on this now, and others who already are  – let’s organize around this goal and make it happen.

Reply to let me know you’re interested to participate, and I’ll get you involved.