One of the benefits of being a lawyer who supports fund managers, rather than being a fund manager myself, is the broad perspective I get of what’s going on in the market. Most of our clients are either first-time fund managers or are investing in first-time fund managers, which provides me with a good view of market trends. Below are three things we are seeing at All Places when it comes to new fund formation.
Experiments with Structuring. The fund formation space is not what anyone would call rife with innovation. Most term sheets and fund documents you see look more or less the same, with some tweaks here and there. This is not without its benefits. For one thing, it makes it easier on LPs to compare terms across funds. But that’s not to say that there isn’t room for improvement.
One thing we’ve seen recently is experimentation with new structures, with mixed levels of success. You may have started hearing lately about “rolling funds.” This is a structure created by AngelList. It’s effectively a subscription service that allows LPs to invest on a regular, quarterly payment schedule. But it comes with a number of additional complexities, including the creation of new “funds” every quarter, and an accelerated management fee schedule that forces LPs to pay 10 years of management fees in the first 4 years of their investment. While this structure may work for friends and family, we are seeing significant pushback from serial investors and institutions, driven largely by their lack of familiarity with the structure and distaste for the fees.
Giving Back. We are hearing from more firms that want to incorporate a charitable component into their funds. This can take a few different forms. Some funds are stating upfront that they will be donating a portion of management fees or carry to a non-profit organization. These tend to be funds that are structured or investing in a way that is mission-driven and want an aligned giving strategy. Others are considering cementing their commitment through certification as a B Corporation (through a private organization) or formation as a public benefit corporation (which is controlled by the state government, like any other incorporation). This approach carries with it a bit more labor, but can also be an even more effective marketing tool to LPs who want to say they are investing with a B Corp or PBC.
Rethinking the GP Commit. One of the things that makes starting a fund so difficult (and nearly impossible for people without pre-existing wealth), is the expectation that GP founders will be contributing 1-3% of the total AUM. For a relatively modest $100m fund this means the founder or founders need $1-3m in disposable capital to invest. That is on top of the liquid assets they need for living expenses as they are also expected to take only a minimal salary. We are seeing founders from underrepresented groups (that have also historically been deprived of opportunities to grow wealth) push back on this expectation and (we hope) LPs are listening. One tool first-time GPs have used to make this expectation more manageable is the management fee waiver, using those to offset the GP commitment. The downside here is that it limits the amount of money you have available to run your firm. There is also increased political focus on this practice because GPs get to treat otherwise taxable management fees at a reduced rate for long term capital gains.
From what we are seeing, societal shifts and awakenings over the last couple of years have inspired more underrepresented investors to set out on their own. This may be part of the reason we are seeing more innovation at this stage, because the makeup of the ecosystem itself is (slowly) evolving. Finance (like law) seems to be one of those industries with no urgency for change, but I’m hopeful we are at the beginning of an age of innovation in asset management.
--Jessie M. Gabriel