Limited Partners, often referred to as LPs, form a unique tribe of investors specializing in allocating their capital to venture capital (VC) funds. These funds, in turn, direct their resources towards startups or, in fewer instances, growing businesses. LPs are known for committing their funds for extended periods, typically spanning 7 to 10 years.
“Spray and pray is not a strategy.”
The most significant advantage that LPs possess is their capacity to infuse capital into VC funds. Nevertheless, this shouldn’t translate into a blind injection of funds without conducting their own due diligence on the VC firm and the fund manager. While passive investing strategies can yield exceptional results over the long term (think index funds), this passiveness still demands a degree of initial diligence.
Picture wanting to grow mangoes using a passive strategy; you’d still need to ensure that you start with a good seed, consider favourable weather conditions, ensure a sufficient water supply, and sow the seed in fertile land for your mango tree to thrive.
So, how should due diligence be carried out by LPs?
Alignment of Objectives: LPs should commence by scrutinizing the investment offering document to ensure it aligns with their investment philosophy. For example, an LP committed to ethical and environmentally friendly businesses should verify that the VC fund shares their vision and outlook to a large extent.
Time Commitment: LP investments in VC funds are primarily passive, meaning LPs have limited influence over or involvement with the invested businesses. Hence, it’s vital for LPs to comprehend the nature of the businesses and the VC firm to ensure their interests align.
Access and Authority: Thoroughly examine the Terms and Conditions document, which outlines the rights and responsibilities of LPs. Any ambiguities or questions should be clarified and documented. The Limited Partner Agreement (LPA) is an extremely important document that details everything both LP and VC should be aware of.
Past Performance: While past performance is not a guarantee of future success, it does provide insights into the fund manager’s and VC firm’s investing style. Although the future can’t be predicted with certainty, collecting information about those responsible for growing your investment is a prudent step. This diligence should not create a bias against new fund managers but rather provide a holistic view of the fund.
Support to Startups: Beyond mere investments, VC firms often offer invaluable support to startups, including business guidance, networking opportunities, and go-to-market strategies. LPs should assess how the VC firm contributes to the growth and expansion of these startups.
Additionally, LPs should review these three critical documents thoroughly and understand them. They are a LP’s best friend.
Marketing Deck: This document outlines the fund thesis, the rationale behind selecting a particular investment strategy, and broad terms. Fund Offering Document: A more detailed document, specific to the terms and conditions of the fund.
LPA (Limited Partner Agreement): This is a legal document that details all the rights of the investor and the VC. Investing in startups through the VC route is among the safest and most straightforward investment avenues. It closely resembles how traditional investors select mutual funds. In both cases, investors tailor their choices based on factors such as risk tolerance, thematic alignment, available capital, fund management, and investment horizon. Similarly, VC investments require LPs to conduct thorough due diligence to potentially reap substantial returns over the long term.
Excluto serves as a bridge between LPs and VCs operating in diverse industries and regions. We provide LPs with in-depth information, enabling them to make initial decisions without the need to directly contact fund managers. Our platform prioritizes absolute confidentiality, and it operates exclusively on an invitation basis, safeguarding the privacy of both VCs and LPs. For additional details, please get in touch with us at admin@excluto.com or visit www.excluto.com to register.
Authored by: Vikas Raina