Four Things VC Funds Look for in a Limited Partner

If you’ve ever played Monopoly and bought the railroads as part of your strategy for game domination, you’ve incorporated alternative investments into your portfolio. It’s no coincidence railroads made their way to the Monopoly game board as alternatives originated in the mid-1800s with funding for the Transcontinental Railroad.

What was once an investment vehicle for the Vanderbilts and Rockefellers has become more mainstream over the last 100 years. According to an Ernst and Young survey, 18% of investors currently use alternative investments, and it’s estimated that by 2024, 27% of North American investors are expected to use alternative investments.

Alternatives include everything from Real Estate & Real Estate Investment Trusts (REITs), Private Equity (PE) & Private Debt, Venture Capital (VC), Hedge Funds, Commodities & Natural Resources, Collectibles (think fine art and wine), to Crypto.

If you’re an investor looking into investments in PE and VC funds, below I outline qualities that some firms might look for in Limited Partners (LPs). My prudent disclaimer upfront: Aside from the SEC’s guidelines for investors, the strategies described below aim to enhance the value you bring to your chosen firm. This is not a mandate for all investors, and all firms have different preferences.

Be Accredited

You could be accredited and not even know it, which means you could be missing out on the incredible potential of alternatives. Per the SEC, LPs must be accredited investors – meaning they meet specific income or net worth requirements. An individual qualifies if they meet one of two financial thresholds:

• A net worth over $1 million, excluding the primary residence (individually or with a spouse or partner)
• Income over $200,000 (individually) or $300,000 (with a spouse or partner) in each of the prior two years, and reasonably expects the same for the current year.

Additionally, investment professionals in good standing holding securities licenses, general partners (GPs) of the company selling the securities (or of a GP of that company), or any “family client” of a “family office” that qualifies as an accredited investor. If none of these criteria are met, entering a partnership may be a nonstarter.

While most PE and VC funds can accept investments from accredited investors, it’s worth noting that some larger fund managers are legally required to adhere to higher thresholds.

Make A Commitment That Lasts

A crucial aspect of becoming an LP in a VC or PE fund is the willingness to commit for the long term. For all intents and purposes, becoming an LP is much like entering into a long-term relationship. As an LP, it’s important to ensure that there is alignment of values, trust, mutual respect, and a strong relationship within the leadership of the firm.

The length of a capital commitment in PE will be longer than that of a commitment to the public markets, and that timeframe will vary depending on the opportunity.

As Senior Partner Chris Van Dusen has written in previous articles, “The extended horizon allows for in-depth operational improvements and strategic changes. Individual investors that invest in PE firms can expect their dollars to be working over this period as well. Whereas VC investments will have shorter holding periods… Because VC firms support startups in their early stages, the focus is on nurturing rapid growth and achieving milestones, thus getting investors paid back faster.” During this time, the investment is illiquid.

As an LP, there will be an opportunity to invest in multiple funds from a firm, potentially during different cycles. Participation in multiple funds is not required. That said, if it fits your investment strategy, it could be worth consideration. For the firm, it ensures long-term stability and continuity in funding. For the LP, it can diversify the portfolio risk and capture opportunities across different market cycles. By spreading investments across multiple funds raised at different times (vintages), investors can mitigate the impact of economic downturns or underperforming funds in any single vintage.

Success is never guaranteed, so it’s best to choose the path that best aligns with your strategy. Firms will release funds with limited space available. Just as the LPs consider which firms make good partnerships with their investments, firms also carefully consider which LPs they want to work with. Firms want to collaborate with individuals who will make excellent partners in the long run. This is one reason that most firms, as is the case with Solyco Capital, are by invitation only, primarily through referrals from limited partners (LPs) or their team.

Provide Value Beyond Capital

LPs are often seen primarily as sources of funding for venture capital and private equity funds. Their value can extend beyond capital, which can be appealing for firms. Providing additional value is beneficial, though not a requirement. It is advisable to get to know the firm’s specific needs and determine if there’s a match with the firm’s aims and the ability to provide support in particular areas. Here are several areas where LPs could contribute additional value:

Investment in Knowledge-Driven Opportunities: There is an adage, “invest in what you know.” By investing in areas you are familiar with, you can leverage your own experience. For example, an LP with a background in healthcare might partner with a firm that specializes in medtech startups; that LP can use their industry knowledge to inform investment decisions and provide nuanced perspectives on emerging trends. The LP can offer a broader view of investment trends and valuations across their portfolio, which can be instrumental in strategic decision-making. This broad market vision helps GPs position their portfolio companies more effectively within the wider industry context. Another way to think about it is to consider investing in businesses or industries that you are interested in and comfortable learning more about. By focusing your investments on businesses or industries that spark your interest, you might be more likely to engage with the subject matter, stay informed about industry trends, and make educated decisions based on your growing knowledge and personal interest.

Strategic Networking: LPs often have extensive networks that can be tapped into to strengthen relationships with a firm and support outcomes. Here are just a few ways:

• Introductions to Prospective LPs: People want exposure to good opportunities. It’s natural to be drawn to investments that your friends trust. Observing a friend’s thorough due diligence and successful outcomes can inspire you to consider similar paths. Joining a fund as an LP is about more than financial investment; it’s about becoming part of a community where relationships and shared experiences are valued.
• Business Development: An LP can introduce portfolio companies to prospective clients or collaborators, which can lead to business growth. Perhaps it’s a purchase order for a product in the portfolio, or a strategic introduction that opens the door for collaboration in other industry verticals. Momentum can come with a simple introduction within the network, and an LP with connections could provide incredible value for the portfolio company.
• Deal Flow: LPs have diverse and extensive networks that can help them identify unique investment opportunities, which might not be on a firm’s radar due to their specific investment criteria or market focus. Additionally, LPs may have insights or access to niche markets and emerging sectors before they attract broader attention, providing a funnel of potential deals that complement a firm’s existing pipeline.
• Talent Acquisition: LPs can assist in identifying and referring potential talent to a portfolio company as they build their talent bench.

Being Part of the Ecosystem

When an LP commits for the long term, they immerse themselves in the fund’s ecosystem. Attending and participating in investor events, for instance, allows LPs to share their experiences and insights, fostering a vibrant community. By engaging with other investors and portfolio company CEOs—posing challenging questions and exchanging ideas—they facilitate a dynamic environment for growth. It’s good for the LP because they are learning and engaging with others. And it’s good for the fund, as it enriches the fund’s network and resources – potentially leading to a more robust and collaborative platform for success.

Conclusion

As alternative investments continue to gain popularity, firms are looking for LPs who not only meet accreditation requirements but are also willing to make a long-term commitment. These firms value LPs who can offer more than just capital – who can bring their knowledge, networks, and active engagement to the table. This contribution from LPs helps create a thriving ecosystem for the fund, with the aim of mutual growth and success. Just like buying the railroads in Monopoly (and all the other assets for game domination), being a good LP involves strategic thinking and a willingness to actively participate in the investment journey.

The views and opinions expressed in this essay are solely those of the author and do not necessarily reflect the official policy or position of Solyco Capital. This content is for informational purposes only and should not be construed as professional advice or an official statement from Solyco Capital or its affiliates.

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