Cheryl and Maxine
Okay, three, two, one. Hey, I'm Cheryl. I'm Maxine. This is First Cheque, part of Day One, the network dedicated to founders, operators, and investors. If you want to be a better early stage investor, this is the show for you. So TLDR, if you don't want to suck at investing, listen up.

Cheryl
All right. So this next episode, I am super pumped for it. This one is for all of you emerging fund managers, first time fund managers, and thinking about raising a fund.

Maxine
Yeah, soon to be fund managers. Whether that's this year, next year, the year after, in 10 years' time, I think this is a really helpful background.

Maxine
But also for entrepreneurs, you know, people who are working with fund managers as their key stakeholders, as investors, understanding their incentives, understanding the environment they're operating in so that you can understand how that might impact their ability to invest in your company to start off with, to follow on if they're already investors, or why it's really hard to get them to respond to a call in certain times of the year.

Cheryl
Yeah, it's 100%. And I think this is a good time of year to be publishing this one. Start of the year, sentiments rebuilding.

Cheryl and Maxine
Yeah. New year, new you and or new fund. Excellent. Let's jump into it. So, uh, actually we haven't even told people the, the, the topic we just, you know, said who it's for. Yeah. Let's just get right in.

Cheryl and Maxine
Just get right in.

Maxine
Just dive right in. You can, you can guess what the topic is based on what we start to talk about. No, no, I'm kidding. I'm kidding.

Cheryl
Okay, so topic is fund cycles. What are they? What do you need to know about how the cycle of a fund works? When do you raise? When do you close? You know, lifespan, everything.

Cheryl
We're kind of giving this broad headline topic of fund cycles, but if anyone can come up with a more interesting title for this after you listen to it, please send us an email.

Maxine
We promise to edit all of the headlines across all of our socials and the links to them. But yeah, so overarching, as you said.

Maxine
Talking about the mechanics, the meat and potatoes of raising funds, deploying funds, raising your next fund, and thinking about, uh, how you structure those.

Cheryl
You know why I think this is really interesting? And I, one of the things that I was listening to something else and was like, Hey, I think we need to talk about this is because we see these headlines sometimes where it's like, uh, you know, fund XYZ is, uh, is raising this much to, to deploy into this category.

Cheryl
And until I understood fun cycles, to me, I read that as in like, okay, cool. They've got that amount of money. They've raised it and now they're going to start deploying. But often that initial article that goes out in the AFR or, you know, startup daily or whatever it is, that article is usually the like kickoff of them saying, Hey, we're going to start to raise.

Cheryl
And that to me, isn't intuitive.

Maxine
No, totally. And I think also what isn't clear is sometimes there are those kickoffs and then they fail to raise. We saw a lot of this in '22 and '23, less in '24, but also some of that. And people kind of announced that they would be raising funds and then the funding market was really, really tough and they couldn't get them away.

Maxine
And so they weren't actually in market. So as entrepreneurs using those announcements as an indicator that you're deploying capital or that a fund is deploying capital can be indicative, uh, but it isn't necessarily that they are out deploying. Yeah. So maybe that's a good kickoff. How do you start the process of raising a fund?

Cheryl
There's this interesting concept in Australia where you kind of have to choose between raising what we call an ESVCLP, which is an early stage limited venture capital fund partnership. I almost got there.

Cheryl and Maxine
I almost got all the letters.

Maxine
ESBCLF? Question mark.

Cheryl
I almost got all the letters. Come back to me on that one.

Cheryl
But, that is a much more in-depth process, but comes along with some tax benefits, and I think we did do a whole episode on that. We sure did. So if you want to learn more about that, jump into that episode. But as a fund manager in Australia, you do need to kind of make that choice first of all. I don't think we'll go too much into it, but that's like a first one to think of is like, well, do I want to do this like more tax beneficial one, but has a lot more admin requirements?

Cheryl
Or can I start small and build up a really good quality fund without necessarily taking advantage of those tax benefits? But it is a lot easier to get started and get deploying and therefore get into market and therefore potentially earn returns.

Maxine
Absolutely. And just as a cliff notes, if you don't listen to a whole nother episode on tax, the main tax benefit is that returns via your fund to your LPs are tax-free.

Maxine
Uh, there's some qualifications and stuff there, but consider it as a, well actually it comes in as your, as income, right? It's tax beneficial and you also get a tax credit.

Cheryl
So as a fund manager, it comes under capital account up until a certain amount. And then as an LP, it comes on under, um, like it's tax-free.

Maxine
Yeah. Yeah. That's right. Excellent. Love the expert in the room. Yeah. When you are thinking about kicking off, as you said, there's that, that consideration of, do I go ahead and register as an ESV CLP and get these benefits for. My LPs and myself, or do I kick off something smaller? I think a material thing that I would name here is I'm seeing a lot more micro VCs step into the ecosystem.

Maxine
So sub 10 million. So for an ASV CLP, you need to be raising 10 million or more. And so if you're raising less than that, then the decision is made for you. You won't be eligible for an ASV CLP, but you can actually start. Deploying once you're conditionally approved as an ESV CLP, if you haven't raised the entire thing, but you have to be pretty sure you're going to get to that 10 million.

Maxine
Otherwise, LPs will invest expecting tax benefits and they will not accrue to them. So it will be pretty, pretty uncomfortable conversation.

Cheryl
It's also interesting that the conditional and unconditional status of getting the ESV CLP as a fund, they give you two years to do that. So there is an underlying assumption there that it.

Cheryl
It could take you two years to raise a fund. What are you seeing in the market? Like, I've seen some funds who told me they were raising 10 years ago and are still raising said fund. The

Maxine
US, at least from the data that I've seen, top quartile is four months. So from initial raise, and that's. In the US ecosystem.

Maxine
So the US ecosystem has a similar process. They measure from first close. So first money in, in your first close to final close last money in, in your final close. And that's four months, which is like outrageously

Cheryl
fast. Oh, interesting though. I'm thinking about like anecdotally the funds I've heard who have said, Hey, we're raising until final close, not from first close.

Cheryl
I'm thinking like the first time I heard them say, Hey, we're raising here's my, I am.

Maxine
I don't obviously, I mean, I only have anecdotal data on. Those ones as well, I would say like, April Underwood did it in 12 in the US, I think, um, for adverb ventures. I'm sure there are others that have raised much faster

Cheryl
than that.

Cheryl
Somewhere between 12 to 24 months is kind of my guesstimate there.

Maxine
Sorry, 12 months is in the middle of the bell curve. In the US, you have to raise in 18 months, so it's a pretty precipitous drop-off. What happens? If you don't raise just, you don't get the necessary confirmation, like SEC confirmation. So once you start raising kind of, you have to close within 18 months.

Maxine
And so you just close at whatever price you've got. But

Cheryl
their version of once you start is first close, right? Not once you say

Maxine
first money in, in your first close. So if you do like a rolling first close. Let's say it takes you three weeks to finalize checks, it's when the first dollars hit your bank account, I believe, is when the timer starts, which can catch some people.

Maxine
Whereas in Australia, we don't have that. As you said there, you can be raising.

Cheryl
It's just when you're conditionally registered, if you're doing an ESVCLP.

Maxine
Right. Or if you're not doing an ESVCLP, if you're using a kind of traditional trust structure, you can just keep going.

Cheryl
Yeah, which is really interesting.

Cheryl
So yeah, between 12 and 18 months is the usual that I've seen. Which kind of begs the question around like, well, if you, if you want to start deploying in six months, then is it realistic to be able to raise that fund in that time? Probably not. Right. And then also if you're thinking about doing a second fund and your timeline around, usually I'd like from what I've seen, usually funds will be deploying the capital.

Cheryl
So once they've done that. Second close, they'll deploy the capital within two to three years from that time, right?

Maxine
Correct. Yeah. So fund deployment periods, you usually have to commit to in your fund docs, and there is some flexibility there. They're not hard and fast, but it's not like we'll deploy in two and you deploy in four.

Maxine
And the reason for that is, um, a big part of funds management and investing in this asset class is vintages. And we've talked a little bit about that on this podcast. And so if I'm investing in a 2023 vintage fund and I'm expecting that fund to be a collection of investments over the years '23, '24, and '25.

Maxine
If I then bundle into that '26, '27, '28, that's not really the diversification I was hoping for. Or alternatively, if you say to me you're investing in '24, then you deploy all of your capital in 2022. Also, not really the thing I was investing in.

Cheryl
Also, not

Cheryl and Maxine
what I was aiming for.

Maxine
There's some flexibility on the edges, but not a material amount.

Maxine
So anywhere between kind of two to four years is the deployment cycle that you've seen, I would say in this current market, I'm seeing lots more fours than I'm seeing twos twos was a very kind of 2021, 2020. Two era thing to do lots of good deals. Deploy, deploy, deploy, deploy, deploy, deploy. Oh, it turns out they weren't such good deals, but '23 and '24, I'm seeing people extend out those deployment periods.

Maxine
And this is all subject to negotiation, right? You can start deploying on a two-year fund cycle and then determine, Hey, that's not going to be the right thing for me. And if you can renegotiate those terms with your LPs and your, you know, the folks that invested in your fund, then you can extend it out to three or to four, or you can build that flexibility into your deal documents.

Cheryl
First comment, I love that we have adopted wine terminology on fund cycles in general, just vintages is fantastic. I have actually gotten a few like wines from funds that I've invested in with the year on them, which is kind of cool. Oh, that's cute. I like that. Second comment, or is more of a question. You say this negotiation, but like, let's say you've got 50 LPs in your fund, are you going to go back to all of them and be like, Hey, actually, if this isn't working, I want to deploy over.

Cheryl
Three years instead of two, do you get them all to like sign a, yes, you're good. Or like, is it just conversation? Like, what does that actually look like?

Maxine
That's a great question. I've actually never seen the meat and potatoes of how you actually deliver that. I know anecdotally folks just negotiate it with their major LPs and there's sometimes like a defined term, major LPs in their LPAs or in their issue documents in Australia, sometimes.

Maxine
It kind of depends on how many LPs you're working with as well. Right? Like if you're working with 50 LPs and you're planning on changing it from a two to a four, I would argue that that's a fairly material change and would imagine that you need to get kind of re-executed documents from everyone. Buy in from everyone.

Maxine
Yeah. Where if we're talking about, you know, three to 3. 2, it's probably not something that's material enough for you to. Uh, need a documentary change, but it is still worthwhile having a conversation with LPs. Or at least an email heads up.

Cheryl
Yeah. And an explanation.

Maxine
I mean, at the very minimum, if, if you can't have a verbal conversation with your LPs about a topic like this, the only way to get in front of them is an email, then I'd seriously consider deepening that relationship or finding new LPs for fun too.

Cheryl
That or, like, I do know a few funds that have A hundred plus LPs and many of them are small checks and it's probably just not, you just don't have the time to give every single one a call. Yeah. So I could see like, you know, the bottom 20 of them just getting an email, but yeah, I think that makes a lot of sense.

Cheryl
I have not personally gotten that email though. I will say anecdotally, a lot of the funds that I'm invested in are deploying very slowly to the point where like my capital calls are like 5%. I'm like, perfect.

Cheryl and Maxine
Yes, let me send you in the thousands.

Maxine  Yeah, so I think, I mean, that's a really important point as you're thinking about for those folks who are thinking about raising a fund, either fund one or fund two, is having a serious think about what is the deployment pace that you want to meet. When you are raising faster, i.e. you're doing two-year deployments and you're raising every two years, there's not a lot of break between fundraisers, depending on how long it takes you to raise a fund.

Cheryl  That's what I was getting at is like, well, if I do the math on like, all right, it takes 18 months to raise a fund. You deploy and say two to three years. And then this kind of brings us back to this concept of like, don't run out of money as an investor, fund manager. Super important. Don't run out of money.

Maxine  So like, you kind of have to start raising the next fund when you close the first one.

Cheryl  Which is a tough thing to pull off, right? I would venture a guess that anecdotally the number of fund managers who are deploying out of two-year funds also correlate to the number of fund managers who are raising funds in sub six months, right?

Maxine  They strike me as like fast raise, fast deployment strategy. So you might be doing smaller funds, for example, or you're Naval. Or you're just, you're just that person. You're just a boss. Yeah. And so you have pretty limitless access to capital and can pretty quickly raise and then be deploying behind that strategy.

Maxine  Whereas, you know, if it's taking you 18 months to raise, then you probably are not in a position to be doing two-year deployment periods because you'll likely be having conversations with LPs ahead of a new fund pretty much while you're still closing those same LPs on fund one, which is a pretty tough conversation to pull off.

Cheryl  Yeah. It's a bit awkward. Like, Hey, great. You just invested in this one. I've made zero investments. Uh, you get to go into fun too. Right.

Maxine  Right. Exactly.

Cheryl  Oh, and the nav is negative because we took our management fees. Oh yeah, by the way, did I mention that you've gone backwards before you went forwards? Want to give me more money?

Maxine  Exactly. Tough conversation to land as you can probably imagine. So most funds, and especially in this market, most funds are doing three to four. So they're raising for

Cheryl  You know, 12 to 18, three to four years deployment period, and then raising every like two to two, yeah, two years.

Maxine  Pretty much. Yeah. So the rule of thumb is you start raising the next fund when you are roughly 75 percent deployed.

Cheryl  Ah, look at that rule of thumb.

Maxine  Rule of thumb. So some people do it earlier. Right. If it's been tougher for them to raise. So in this market, you would expect more people are doing it slightly earlier. Maybe they're two thirds of the way through their funds. So 66 percent of the way through their fund. It's tough to do it any earlier than that, because once you start having those conversations, it's similar to a founder, right?

Maxine  Having conversations about fundraising means you're fundraising. And so, you know, once the momentum kicks off and you really want to foster that momentum in your race. You need to be ready to kind of run at it. So you need materials and data rooms and all of those kind of things just like a startup. If you're raising fund two, you want some pretty, uh, juicy nav numbers.

Maxine  Uh, you ideally are anywhere between kind of 1.8 to two x nav by the time you are raising your next fund. Um, if you are raising from institutionals, they generally look at three funds ago. So you can imagine if you are an emerging fund manager.

Cheryl and Maxine  Hey, I'm first fund.

Maxine  Yeah, fund one minus three equals no funds for them to look at.

Maxine  So you're not raising from them. But if you are raising from family officers or those folks, they can sometimes be comfortable or the bigger institutional family officers. They'll sometimes be comfortable to look at kind of fund one and fund two. And that's the point at which you start talking about. to those institutions.

Cheryl  So what about this concept of like, I think angels get told this concept of don't run out of money a lot. And we talk about that as angel investors, like don't run out of money. How does that apply for fund managers? Like that's still a really important concept, right? Like you don't want to run out of money as a fund manager because it still means you can't deploy.

Maxine  I mean, I think the best analogy that I can think of when people talk about this in fund management is imagine a scenario where you are a business owner and you have nothing to sell. Like you're a supermarket and you just got no food to sell.

Maxine  Like, what do you think is going to happen? People are going to not come to your supermarket anymore, right? They're not going to come to you to purchase the product. So depending on how long you are in market, For without anything to sell, it becomes kind of performative for you to meet founders. Now, sometimes fund managers will still take those meetings.

Maxine  If we're talking about a month or two, that's kind of bridging that period. I think that that's reasonable, but there's a point beyond which it starts to become slightly disingenuous that you're meeting. Founders that you're actually not able to invest in. You're wasting their time. You're wasting your time.

Maxine  And so you need to make sure that as a fund manager, you always have enough capital. There's also a fund construction reality, right? We keep beating that drum on this podcast of the importance of the power law. I actually don't know the month of the year that Canva raised their first round. Let's say it was somewhere between July and October of that year.

Maxine  If you just happened to have no money. In that period of time

Cheryl  and you saw them, you could have invested

Maxine  and you didn't invest like that is a sucky way to miss one of the best success stories out of the Australian ecosystem. So there is a reality that, you know, you have to have that surface area with luck by having deployable capital so that you can deploy when you meet really interesting companies.

Maxine  Also from a fund. Perspective, you don't want to have a situation where, let's say you're investing over a three-year period, you run out of money at, you know, two and a half and you're just not deploying for that second half, because then again, your LPs are not getting the diversification, the time-based diversification that they need.

Maxine  Are painful

Cheryl  that they thought they were getting it's kind of like your supermarkets empty, but you're on the street corner still asking people to come in

Maxine  correct. Yeah. Yeah. You're still like hawking on the street corner of being like step right up tomatoes on special

Cheryl and Maxine  with the with the flippy sign. You know, you're out there like spinning a sign.

Maxine  Yeah, exactly. Like it just is a bad dynamic for everyone. Good analogy. I like that. If you're raising fund one, this is obviously not something you have to be thinking about. If you're an angel investor, it's something to think about, right? To make sure that you don't run out of money. But if you're raising fund two or you're planning to raise fund two, then it's something really to think about, especially as you are kicking off fund one, ideally you're going to raise fund two in a couple of years.

Maxine  Deployment pace. Really matters. Check size really matters. The right math around reserves really matters. So that you don't run out of dry powder before you get to that, like, in range for that deployment period. Next fund. Yeah, for that next fund. And then get stuck in a situation where you need to raise capital early or not be able to raise because you need to give some time for your NAV to grow sufficiently that you're an interesting fund to invest in for Fund 2 or Fund 3.

Maxine  And then you are, you need to make sure, you know, you're really in a tough spot.

Cheryl  It makes me nervous, honestly, when I think about stuff like that, because I'm like, this is, this is the scary things about raising a fund. And this is why I don't want to do it until I'm like, absolutely certain. Because the other thing is like, this is a 10-year thing, right?

Maxine  So each time you commit to raising a new fund, you're committing to another 10 years of doing this.

Maxine  Yeah. To 12. Yeah. Most of them have two-year extensions. So, 12-year commitments. 10 to 12 years.

Cheryl and Maxine  What

Maxine  do you, do you know what you're doing

Cheryl and Maxine  12 years from now? I don't know.

Maxine  I'm operating

Cheryl and Maxine  this fund. Oh, right. Yes.

Cheryl and Maxine  I've already

Maxine  committed to it. Actually, for 10 years. 10 more years.

Cheryl  You know what I think is interesting, though? I think the micro funds do have a bit more flexibility in that way. Like, the micro funds that I've seen have been able to say, okay, I'm just going to This is, we're raising a fund, we'll deploy into 20 companies over two years, and then we'll decide, like, if we run out of money, that's fine, because, you know, this is a specific purpose of what we're doing this for.

Cheryl  So I do see micro funds having a bit more flexibility on that. Would you agree?

Maxine  I would totally agree. Yeah. And I think it's one of the arguments for running a couple of syndicates and then micro funds before you step up into building a bigger fund, like an MVP fund, you know, first of all, testing out your investment thesis is really important and that you can like build a brand behind.

Maxine  What it is that you're looking to deliver, but second of all, you know, it's something where you have flexibility, right? Like if your micro fund is a million dollars, if you invested over one year or three years, depending on your LPs, there's probably a lot more understanding there.

Cheryl and Maxine  Yeah.

Maxine  You can do it at the same time as your.

Maxine  still operating, you know, there is an ability for you to have much more flexibility. No one's going to get annoyed if you don't start raising fund to, you know, when you, uh, you've deployed 750 K where's the next vintage. Yeah. Yeah. You know, it's not, it's not as intense. And so it allows you to kind of play around with it.

Maxine  It's kind of the equivalent of doing your learning checks, you know, deploying smaller check sizes when you first start off. So you can kind of run some work through the pipes and then kind of build from there.

Cheryl  Yeah, 100%. One of the other things that I see or have heard anecdotally, curious to get your thoughts, is that funds tend to, and maybe this is with the bigger funds, but funds tend to deploy into smaller, like smaller checks into earlier stage, more riskier companies.

Cheryl  At the start of their deployment period. And then later stage, bigger checks, slightly less risky, uh, in our world. Companies near the end of that cycle of the fund deployment period. Is that something you see?

Maxine  Super interesting. I, I have heard it narrated. Anecdotally from the fund managers, but I haven't seen it in their behavior.

Maxine  And from what I can see, the emerging fund managers, they're more conservative investing out of like when they're deploying and raising at the same time, because there's almost more scrutiny on investment decisions coming in because they're looking at. The portfolio that's coming into that present fund, then looking at the, the fund overall.

Maxine  Whereas when you are a larger fund manager, let's say you're on fund four or fund five, you have sufficient track record that they can look at the stacked funds and make a call across that track record as opposed to what's specifically going into that fund.

Cheryl  See, I think it tracks though, because if you think about like, let's say it's a four year deployment period, and your fund lifespan is 10 plus one plus ones.

Cheryl  You know, potentially 12 and you're at the end of that four year deployment period, you're going to be looking for companies that then need to be able to possibly exit by within six to. seven, maybe max eight years. So it makes sense to invest in slightly later stage companies because you're looking at a shorter exit time horizon.

Cheryl  I also think that like, anecdotally, I've heard things like, well, you know, at the start of the fund, you're excited. You're like, yes, amazing, super great idea, early stage stuff all the way. And then by the time you're getting to like, the four year deployment, like you've kind of got three to four checks left and you're starting to think about the next fund and you're looking at that nav number and you're thinking, oh, maybe I need a safer bet.

Cheryl  Shoot.

Maxine  Yeah, I think, I think that's a wonderful point. I do think you definitely see folks deploying to later stage companies if they've got a multi stage strategy, but that's more a thoughtful fund construction as opposed to like a trending psychological state over time, right? It's more, yes, absolutely, they're lower risk because they are later stage.

Maxine  But that's because as exactly as you said, right, when you need to make sure that they're paying out or that they have a likelihood of exiting in that time period, you don't want to be in a situation or ideally don't want to be in a situation where you're distributing back shares when you're closing the fund at year 12 or being forced into a situation where you're having to.

Maxine  So, uh, yeah,

Cheryl  well, yeah.

Maxine  If you're selling them at secondaries or even kind of selling them as part of a transaction, you know, but forcing the company into a transaction to try to, Kind of get those, that liquidity back into the fund. That's not pretty. So yeah, I think that's absolutely the case, right. For folks that are running multi stage strategies, there is something to be said for that kind of having lots of cash recently raised kind of ready to be deploying, I can definitely see a psychological state where you're more likely to make.

Maxine  More risky investments within your investment strategy when you're first deploying out of that fund. So I guess that is a mental note for the entrepreneurs listening to this. If you happen to be raising something particularly speculative in your stage, try and hit a fund as soon as they've raised, as opposed to on the back half of their deployment, you might be more lucky.

Cheryl and Maxine  Hey, you just raised, we're super risky, go. Go.

Maxine  I wonder for you, I mean, I think you get to see some really interesting micro funds, right? Like an amazing vantage point across the micro fund ecosystem. Do you see these dynamics anecdotally across that group or do they have less of that pressure of kind of fundraising cycles?

Cheryl  I think they have less pressure. Like micro funds tend to have more flexibility. I think because people aren't writing. You know, millions of dollars into like, if, you know, 20 million fund, you've got at least a couple of 5 million checks in there, at least a few. 1 to 2 millions. Micro funds generally don't have anyone who are writing over like a 500k check, right?

Cheryl  So, you know, maybe in terms of the what that means for their wealth is still similar But I think it's just a smaller amount of money and so people aren't as scrutinous about it if that's a word I think micro funds also by nature have to be more thematic and niche And so that dynamic comes into play more rather than like, oh, let's just find big bets and exciting stuff It's like well, we've said that we're going to be investing at the like seed stage pre revenue, you know tiny two person company in the med tech and health tech and digital health Big AI data space.

Cheryl  It's like, well, that's a very specific group of companies. Right. Um, and you can do that because if you're only raising 5 million, then like there probably is 5 billion worth of investment deals that are great out there. And so if you're sticking to that thesis, then I think the rest of it doesn't matter too much.

Maxine  It's true. I mean, I think that you get a lot more flexibility when you are operating a micro fund as someone operating a micro fund versus, you know, taking that step up where you do have quite significant and often much more kind of mature capital allocators, sophisticated LPs.

Cheryl  Yeah, once you start getting supers involved, then they're, it's a whole other ballgame.

Cheryl  Yeah, that's a whole other ballgame.

Maxine  That's a whole new kettle of fish for fund managers.

Cheryl and Maxine  We should get someone on to talk about what it's like to take super money into your fund.

Maxine  Oh, we should. Fun fact. I've heard this anecdotally, that the superman, the supers haven't added any 2019. Yeah, I think they've only deployed to the top three.

Maxine  Yeah. Wild. That means they held back 2020, 2021, 2022. They didn't invest in any of any net new fund managers coming out of that, which I can kind of make sense. I can kind of understand because, you know, they're risk averse, so they're probably investing in funds four plus, and there's just only a handful of funds that are anywhere near that maturity.

Maxine  And so that sounds like they're investing in like three or four of the funds that are at that level of maturity.

Cheryl  Yeah, and it's not just a maturity, it's size, right? Like, ESPCLP funds have a mandate that no one LP can own more than 30%.

Maxine  Mm hmm.

Cheryl  So, you need a, a fund that is. It's mature enough for them to consider it, but also large enough that when they write their really large checks, because supers have to write really large checks, like they're not getting out of bed for a million dollar check here, so that then it has, they want to write their really large check, but it can't be more than 30 percent of the funds.

Cheryl  You have to have a big enough fund to be able to accommodate that.

Maxine  Right. Which is a pretty normal dynamic across a lot of institutionals, right? And the reason they don't want to be more than 30 percent of the fund is it skews behavior. Well, theoretically it skews behavior of the fund managers.

Cheryl  Yeah, that's actually a regulation for ESVCLPs.

Cheryl  Oh, interesting.

Maxine  Okay.

Cheryl  Yeah, so it's not, it probably is a desire from the super as well, but there may be a scenario where the super is like, Oh, well actually this is perfectly on theme for us. Like, yeah, we'd love to be your anchor. Cool, we'll give you 30 million. Oh, but you're only raising 50 million? Crap.

Cheryl  Okay.

Maxine  Yeah, looks like you're raising a 90 million fund.

Cheryl  So I could see a scenario where the super might want to do it, but no, the SVCLP regulation doesn't allow it.

Maxine  Yeah, very cool. Actually, not that cool for the emerging manager ecosystem. No. I don't think we've done a good job. In a lot of larger ecosystems, the super funds have partnered with funder funds or actually with fund managers and done kind of emerging manager programs where they invest in the funder funds and the funder funds invest in the emerging managers and then the super fund gets to invest in the emerging manager that's like top of the grade for that, or the managers top of that grade for that, that funder funds.

Maxine  But I think our ecosystem is probably too small, it would be tough and too fee sensitive.

Cheryl  I think our ecosystem and the incentives we've placed around fund managers are good, but absolutely due for a refresh. Absolutely. They have been designed with a lot of good outcomes in mind, but we have outgrown them pretty quickly.

Cheryl  And I think that's a testament to how quickly our ecosystem has grown over the last 10 years, but we have outgrown them. And so they are now holding back some of these Dynamics that should be helping our ecosystem progress to being a more mature ecosystem that has some of those things. But I think the current regulations, especially around the SBCLP, are holding them back.

Cheryl  Now I do know, and I will give government credit, I do know that they are open to suggestions. And I know there are some players, including the big, the big three, and some law firms that work for them, that are pushing some of these changes to improve the system. But personally, I don't think it's quick enough and, you know, we can always do better.

Maxine  Right. Yeah, absolutely.

Cheryl  One of the other things I think is, uh, really interesting to cover is around the fund size relevance and why it matters. And often what I see is that this like kind of 40 to 50 million cutoff. So when I look at funds. they will usually be somewhere between, they'll be like, well, we're raising between 25 to 50, or 40 to 50, or 10 to 50, or like 10 to 40, right?

Cheryl  So like, I feel like there's this invisible line at the 50 million dollar mark, and I'm actually kind of unclear as to why. Oh, interesting.

Maxine  I would imagine those funds, I'm assuming they're all early stage funds.

Cheryl  Yes, but even like, then the next bucket up is like, okay, well, we're raising 50 to 75 or 60 to 80 or so like, I don't think I've ever seen a fund that says we're raising 40 to 75.

Cheryl  Like, no, there seems to be this line there.

Maxine  I would imagine that that line probably represents the realities of fund sizing that you do, right. And kind of similar to, for founders when they're thinking about how much Do I need to raise for my company? It's a similar dynamic for funds. You're having to think about how many companies can you deploy to?

Maxine  What kind of ownership positions can you buy in those companies, right? You can't deploy a three mil. Well, you can, you can, but it's inadvisable to deploy a 3 million check into an idea stage company at a valuation of say 30 million. It's done, but it's not, not a great outcome for the ecosystem. And so.

Maxine  There is a certain number of companies that you can support, right? For a super concentrated fund. That's often around the kind of five to seven mark. And you'll see that at growth stage at the very earliest stage, it's, you know, anywhere between, well, it can be up to a hundred, but mostly you'll see funds around the kind of 20 to 40 mark doing early stage.

Maxine  stuff because it's much more hands on and there's a certain amount of support you need to give them, but you need diversification. So you're trading off the ability to support them, diversification, how much you can meaningfully invest into those companies at current and predicted market rates. And then lastly, the reality of the venture ecosystem or the venture fund model is that you Your revenue for your business is 2 percent of the committed capital to your fund that you take as management fees.

Maxine  So, you can imagine, you have an incentive to increase funds under management. Increase the amount of capital that's in these funds because you're taking 2 percent of that number as your revenue. But also, if you raise too much, you can't actually meaningfully deploy it into the companies behind the strategy that you're chasing.

Maxine  So I would imagine at a 50 million fund number, that's kind of the upper max for the size of check you can write in, plus the number of companies that you're looking to invest in over that period. Whereas if you're doing growth stage, you may be doing slightly less companies, but you are doing, uh, kind of a larger check size.

Maxine  Obviously for these funds at the 50 million mark, those people are usually doing a primary fund and then an opportunity fund. So primary fund being the company, the fund that you invest in, probably your initial check, maybe your second check after that, sometimes even a third check. And then you have an opportunity fund or like a follow on fund.

Maxine  So you're maintaining your positions over that period of time.

Cheryl  Yeah, we tend not to see first or even second fund managers doing opportunity funds though. Typically we see, like, you'd start with a core fund and it's not until, like, what, fund three or four that we start to see fund managers going, okay, maybe it makes sense for us to do an opportunity fund now where that, and for anyone following along at home, the definition there is like, it's a fund dedicated to just investing in the follow on rounds of your initial investments because they're Like their stage at which they are, they've gotten to is to later stage for the thesis of the current fund that you're deploying, but they're still great investments and your fund has pro rata rights, which means that you are essentially forgoing the potential value there because it doesn't fit into the fund thesis that you have, but you have.

Cheryl  The ability to invest. So a lot of funds will then raise a opportunity fund or a follow on fund or continuity fund. I'm sure there's six other names that I'm forgetting. Those are the main ones I think. I don't know that I've heard any others out there.

Cheryl and Maxine  Again, we'll just like,

Cheryl  just call it whatever. It's just gonna get totally, yeah.

Cheryl  But that fund is designed to then take advantage of those pro rata opportunities and to double down into, uh, into those winners essentially from the first fund or first or second fund. And often I think the opportunity fund will, uh, invest across, so like both if, let's say a fund has a fund one and a fund two, the opportunity fund would not discriminate between the two.

Cheryl  You wouldn't do an opportunity fund just for fund one, you would just do one opportunity fund that would invest, uh, into companies that are doing well for both of those, uh, vintages.

Maxine  Yeah, the little lols from the word vintage every single time. It's also a methodology that I'm seeing a lot of people use to kind of benefit from the fact that companies are staying private for longer.

Maxine  So you can imagine, as you said, right, fund one, you don't really raise an opportunity fund because none of the companies you invest in there will be mature enough for the opportunity fund to have anything to invest into. Fund two, that's probably also true, right, depending on the stage that you start investing.

Maxine  You know, you're usually coming in two rounds after that. So it's three to five years kind of after your initial investment. But by fund three, you then ideally have a group of investments that you are in a position to follow along. That you have fully capped out your follow on capacity within the existing funds.

Maxine  But it also is a good circumstance, like we were talking about before, in circumstances where companies are private for longer. Some funds are starting to sell their primary positions to their opportunity funds,

Cheryl  thereby generating those returns for their initial fund LPs.

Maxine  Yep, correct. And often not necessarily like there is overlap in those LP groups.

Maxine  It's not a one for one, but there is overlap in those LP groups and they do it as part of a transaction. So there's no kind of untoward valuation dynamics. So they do it as a part of a transaction. They sell part of their position to their opportunity fund and their opportunity fund holds it for another couple of years before that, that fund matures.

Cheryl  And theoretically you could, if you wanted a, um, less risky, risky relative to our asset class. Keep in mind, all of these are extremely risky relative to the broader investment market, but less risky in our world. Then you could only invest in an opportunity fund and theoretically it would be only investing in those winners and have better access than if you were to invest into a later stage fund.

Cheryl  Is a thesis.

Maxine  Right. I think often for the kind of top quartile funds, they actually only allow existing LPs into their opportunity fund for that reason. Um, you know, to try to diminish the number of people that just want to cherry pick, so to speak. Having said that, the majority of your returns come from your first cheque in your winners.

Maxine  And so sometimes you have underlying funds that perform on a IRR basis to a higher degree than your opportunity fund, because you hold it for longer and you come in at higher valuations.

Cheryl  I think, though, if you were already invested, and you decided not to go into, like, let's say you went into fund one, fund two, and then you were like, hey, I'm not actually down for fund three, but I'll do your opportunity fund, I bet the fund would be like, yeah, yeah, okay.

Cheryl  Yeah, yeah. No, I think they'd let you in. Yeah, one thing that's not talked about too much, or actually in our world is probably talked about a lot, but I think isn't covered in the broader, like, investor LP. Landscape and especially for emerging fund managers, uh, is this concept of like, when do you start trying to generate exits, right?

Cheryl  We've got everybody loves to raise a fund. Everybody loves to deploy but When it actually comes to that like seven years down the road, you know exits don't just materialize I think when we were talking to georgie that was one of the things that she was talking about, like, they put a lot of focus into, like, working with the companies to generate those exits.

Cheryl  So, in terms of our, like, fund cycles, if you're an emerging fund manager thinking about, like, okay, well, I'm, you know, here's my period of raising, here's my period of deploying, here's my period of raising second fund, where in that cycle do we put the, like, start working on exits?

Maxine  Right. Well, for some folks, they say start working on a kind of the year after your deployment period.

Maxine  If you're sitting on a 10 plus two and your deployment period is three kind of year four is when you should be starting to think about exits. And the first exits that you will be facilitating will be to acquisitions, right? They're companies where the theses didn't prove out or the market conditions didn't.

Maxine  materialize in the way that you thought they were going to, or there was execution misses. And the outcome being that it's very unlikely the company is going to be able to get to where it needs to get to. And, you know, they might not be able to raise again. So you're starting to see kind of four years, four to six, you're starting to see the middle of your pack start to need.

Cheryl  Yeah, it's the, the mediocre ones that like got somewhere, but not all the way there.

Maxine  Correct. Right. Exactly. And so for that group, you're probably starting to work on relationships, starting to work on strategic partnerships and those kinds of things to get them into an acquisition position in that period of time, kind of for anywhere all the way through to kind of year 12.

Maxine  That's the majority of the work that you end up. Doing in that period of time, it's actually a side note why it can be so disastrous for a company. If the partner that invested in them originally ends up leaving the firm, then that company, when it comes to exit time, it can be a really bumpy transition, transitioning to a different partner because the partner might not know the business that well

Cheryl  and getting their buy in.

Cheryl  Exactly. Yeah, because it's a lot of work. I mean, the way Georgie described it.

Maxine  Yeah, yeah. I mean, also, a lot of these early M& As, they are tough, right? For the founders.

Cheryl  Yeah, because there's no clear winner. It's not like, hey, you're nailing this, give it to me for 10 billion. It's like, ooh, we might buy it.

Maxine  Right. And which over the last couple of years, the answer was we're not buying it.

Cheryl  Yeah.

Maxine  We're not doing that. And this is the kind of lament that you've been hearing from the Valley for the last couple of years, which is no one's buying. And by the way, you're making it much harder from a M& A regulation perspective for even the middle of our pack to be bought because you've changed.

Maxine  The amount of overview that you are giving these M& A now TBD with Trump in what's going to happen there, but it was a kind of big, big challenge. The middle of your, of the venture portfolio was really tough to start to see exits from that group. So you're getting not a lot of liquidity through and as a fund manager, if you're getting to fund five.

Maxine  And you've got no DPI, which is distributed paid in, i. e. you started to actually pay back that fund. It's really hard for you to stay in business, even by fund three to four.

Cheryl  I'd be surprised if you got to fund five, right? Like fund four, I feel like you'd still be looking at like, even if it was 0. 6 returned.

Maxine  Yeah.

Cheryl  Like I'm, surely you're not raising fund four with zero DPI.

Maxine  Well, I think it depends on how much your TVPI is looking, is looking at, especially over the last couple of years, right? There's a lot of people where their DPI is pretty woeful on funds one, and sometimes even fund two because of the M& A environment.

Maxine  And I think LPs, that is what's sitting underneath the frustration that a lot of LPs have had, which is they're just not seeing that liquidity back. So I think fund five is like, you're dead in the water.

Cheryl  Similar with angels though, right? Like I look great on paper. Right. Not so much in real cash.

Maxine  Right.

Maxine  Not real cash. So I think when you're thinking about this as a fund manager or you're planning on being a fund manager, planning liquidity over that period of time can be really useful. There's not a handful of folks that are doing secondaries, but they can be valuable to develop a relationship with as you start to go.

Maxine  Along that journey, just in case the M& A environment is tough to navigate, although all predictions are that it's going to be an easier year this year.

Cheryl  And if you want a deeper dive into why M& A health matters, I think we also have an episode on that. So jump into that one.

Maxine  Yeah. Us nerding out on liquidity dynamics.

Maxine  You'll love it.

Cheryl  Spoiler alert. It's not all doom and gloom as I was worried it would might be.

Maxine  No, it's great. You get money back. Liquidity. It's the best thing. Yay!

Cheryl  Anything else we need to cover in fun cycles? I feel like this has been a pretty

Maxine  I think we've covered most of it. I think the last thing to say is it's impossible to get it a hundred percent right, right?

Maxine  As you are planning on a fund one or maybe planning a fund two or fund three, just try to be diligent and try to plan ahead. Ideally plan it as you are building the fund as opposed to planning it at the end so that you can set yourself up for success at the end and the number of people that haven't fully planned out their deployment period.

Maxine  He's problematic.

Cheryl  Yeah. You just see it in a deck, right? Like the fun deck will be like, yeah, three years deployment period. I'm like, yeah. Okay, great. And then they get to the end or get halfway through and they're like, we're not on track.

Cheryl and Maxine  Right. Exactly. This has been awesome. Amazing. Thank you, Maxine.