As the Managing Partner of MGV, Marc Schröder is focused on working with world-class tech entrepreneurs and establishing the MGV legacy.
As global economies traverse the unpredictable tide of financial turbulence, the quest for secure, profitable investment avenues becomes paramount for limited partners (LPs). Historically, large, well-established venture capital funds have attracted LPs due to their size and perceived stability.
However, there’s a new contender on the block, one that offers intriguing potential and attractive returns, particularly during times of economic uncertainty—emerging managers.
In contrast to their bigger counterparts, these emerging venture capital funds typically manage less than $100 million in assets. They are agile, proactive and arguably more attuned to the market’s shifts and turns—ultimately driving outsized returns. These fund managers are also driven to raise their next fund and understand that there’s no margin for error in delivering strong performance.
I know these feelings well because I’m one of these fund managers. I came to the United States a few years ago with a single dream—to start an early-stage venture fund with a unique vision and strategy. Over the years, I’ve seen the difference between the mega funds and the hands-on, operator-focused venture funds and the impact these types of fund managers can have on founders.
The Benefits
Here’s why investing in emerging venture capital funds can be a savvy move during economically challenging times.
• Greater accessibility and engagement: Seed-stage emerging managers, due to their size and structure, can often provide a more personalized investment experience. Unlike their larger counterparts, which often maintain a high entry threshold, smaller funds often have lower minimum investment requirements, thereby enhancing accessibility for LPs. In my experience, they are also more likely to engage LPs in strategic discussions, providing them with an opportunity to earn industry insights and knowledge that equip LPs to make direct investments.
• Embracing innovation and disruption: I’ve noticed smaller VC funds are traditionally more inclined to bet on early-stage, innovative startups. These smaller, disruptive companies can thrive during economic uncertainty by providing novel solutions to emerging challenges. By positioning themselves at the forefront of innovation, emerging managers can offer LPs exposure to potentially high-return investments.
• Agile investment approach: Large funds often suffer from a “bigger is better” mindset, which can lead to slow decision-making processes and a lack of flexibility. In contrast, emerging managers are known for their hustler mindset, agility and swift response to market shifts. During uncertain times, this nimbleness can make all the difference, allowing funds to seize timely opportunities and pivot quickly if an investment thesis no longer holds. Many emerging managers tend to also possess a motivated, operator mindset, the creativity of which can be truly extraordinary. Being able to make decisions quickly and pivot on a dime can make all the difference in uncertain markets.
• Extreme specialization: The mega-funds generally invest broadly across the entire startup ecosystem but very rarely possess the specialization necessary to deeply understand a niche industry vertical. Meanwhile, there are emerging funds entirely devoted to a specific sector. These funds often invest enormous amounts of time and effort to integrate into these small networks and develop deep knowledge of the space, relationships with the key players and earn access to uniquely valuable dealflow.
• Higher potential returns: Various studies have indicated that smaller VC funds often deliver higher returns compared to larger funds. This is partly due to their ability to identify and invest in overlooked or undervalued opportunities, thus maximizing potential returns for LPs.
The Risks
Investing in smaller venture funds comes with certain risks.
• Emerging reputations: Many of the best-emerging managers are still earning their reputations, so LPs should deeply know the managers they are investing in and establish trust in their abilities as an investor.
• Additional friction: Also, due to the small size of the funds, family offices and institutional investors face additional friction when deploying capital across multiple small funds. Additional legal paperwork, reporting and analysis, etc., come with the territory—which is why many institutional investors opt to deploy capital to the mega funds.
• Industry-specific tilt: Lastly, investing in emerging managers can also result in an industry-specific tilt to the portfolio, so LPs should be deeply aware of the expertise and focus of the emerging managers they wish to invest with.
Making Investment Decisions
When considering capital deployments into venture capital, especially in early-stage, LPs shouldn’t be looking for bond-like return structures. The name of the early-stage game is getting in early and deriving significant (10x minimum) returns.
This sector comes with obvious risks, but it’s about hitting home runs instead of base hits. Base hit returns can be found elsewhere with less risk.
Before investing in early-stage emerging managers, LPs should consider how this sector fits into their larger investment strategy and spend time getting to deeply know the fund managers they wish to invest with.
The biggest question on an LP’s mind when considering deploying capital to an emerging manager should be, “Is this a person who I can trust to deliver the returns I’m seeking?” With that context in mind, it truly makes the most sense to seek out the best-emerging managers with great access to deal flow and a proven track record of picking the best startups.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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