Imagine you are the manager of a seed stage investment fund. Your job is to make money for your investors through selecting and managing a portfolio of private investments. You work hard to find good deals, to negotiate the terms, and to shepherd each deal to exit. You do this ten, twenty, thirty or more times in your fund, often looking at dozens of deals before making one investment. So how do you get paid?
If you are successful, a portion of your compensation will be a percentage of the profits you return to your investors. Known as “carry,” usually you will receive a percentage (typically 20% or less) of the funds distributed back to your investors after you have returned all their capital.
Occasionally, some of the investors in your fund (usually known as limited partners, or LPs) tell you they would like to invest an additional amount alongside you in a particular deal. This can be good for the company, in that it may receive additional capital under the same terms for little incremental work on management’s part. This can be good for the investor in that you have done the due diligence, negotiated the term sheet, and will monitor the investment until liquidation; the investor just needs to write a check.
But you have done all the work up to this point, and will do the difficult job of watching after the investment, likely for years. You could do this simply as a service to your LPs. But there is also a way to be compensated for this work – with carry.
The way to do this is to set up a syndicate with you (or more likely your management company) serving as the managing member of the syndicate. You need not invest any capital in the syndicate; you are investing your time and your expertise. As the managing member, you are entitled to a fee for these services.
One of our clients, the Portland Seed Fund, has done just this. When they prepare to do selected investments, they let their limited partners know of the deal and that there is room in the deal for the LPs to invest if they choose to do so. If there is enough LP interest, a syndicate is formed with the Fund’s management company serving as the managing member of the syndicate. As compensation, they are entitled to 10% of the carry in the syndicate for this specific investment.
Under this arrangement, all three parties benefit: the company receives more capital with only minimal additional work; the LPs get to invest knowing that the Portland Seed Fund managers have vetted and will monitor the investment, they get access to investments they might not otherwise get into, the LPs may be able to invest at a smaller level than the company would otherwise allow; and the managers have the opportunity to earn carry on additional funds with only minimal additional work on their part. And as an added benefit, the total investment results in only two entries on the cap table, simplifying governance and investor relations for the company.
Of course, you do not have to be a fund manager to be compensated. This technique may be used for others who agree to serve as managing member of an investment syndicate. Loon Creek can service both syndicates in which the manager is a volunteer and syndicates in which the manager is paid. If you are thinking of being the manager of a syndicate, give us a call. We can help you understand your alternatives and provide guidance as you implement them.
Loon Creek specializes in syndicate formation and management services for private investors (and for the companies in which they invest). You can learn more about our services on our website.