News & Insights

What would VentureSouth do?A fair follow-up question on these posts on venture capital fund management fees is: so what does VentureSouth do?You hopefully will not be surprised to learn that we use the step-down approach on our sidecar funds: a percentage of committed capital during the investment period, then a percentage on (net) invested capital during the harvesting period.In VentureSouth Angel Fund I, which was the first fund and very small (<$2M), the percentage was 2.5%.As the funds have grown and we have leveraged operational efficiencies – both within the funds and across VentureSouth – later funds have been 2% using the step-down approach.As we said, we think this is the most reasonable approach, and we try to practice what we preach.

As a final post in this series, here are a few places where you can learn more about sidecar funds. As we said before, information is not easy to come by here, so if you have any better sources we would love to know about them.VentureSouth Angel FundsThe Angel Capital Association has additional material on side car funds, mainly from the perspective of helping angel groups understand the benefits of creating their ownSide car funds introduction from Foley Hoag (link here, downloads). This is more aimed at explaining to angel groups why they might consider having a sidecar fund, but the material remains useful.Seraf - a fine purveyor of angel education materials - discusses sidecar funds towards the bottom of this post (scroll down)

As we wrap up this series, a quick post for entrepreneurs to ask: should I care about whether an angel group has a sidecar fund?As an entrepreneur, you should diligence your investors just as they diligence you. This is likely a long journey, and one filled with more than the occasional challenge, stress, disagreement, and disappointment. This diligence is wider than sidecars, but we’ll skip for now the things to look out for in investors in general.Specifically on sidecars, here are a couple of considerations:Firepower: VentureSouth’s firepower is essentially doubled by its sidecar. If you can get a $250,000 investment from our members, your check is for $500,000 if a VentureSouth sidecar angel fund matches. Double the firepower for the same amount of pitching, roadshow, and diligence effort.Signing authority: Pooled investing means delegating some authority to the fund managers. Are you confident that these managers have the authority to make decisions you need them to make, and will be around to make those decisions?Compliance: Back to my soapbox, if your investor is not compliant, the downstream cascade can impact you, even through no fault of yours. For example, if the fund has a bunch of unaccredited investors that are, ultimately, your investors, you need to know that!Cap table complexity: A sidecar means a separate investment vehicle, and so two different entries on your cap table. You probably don’t mind that - two $250k checks is a lot tidier than a bunch of individuals! - but cap table complexity is always something to minimize.What else? What other things do entrepreneurs need to ask their investors that are using sidecar funds?

One of our pet peeves is seeing fundraising efforts ignoring the rules on general solicitations.As a quick primer, most of this type of private capital is raised under the 506(b) exemption to the Securities Act. The details are arcane, but the key is that these funds may not advertise. They cannot put on their public-facing website anything that advertises a new fund or reveals it is fundraising.Yet you see funds advertised everywhere. This ranges from the blatant websites to more-subtle techniques. A common one is the “we’re proud to announce the first closing of the fund” approach. Check out the search results for “first close” on Techcrunch or Google News and you’ll see even big funds doing this; small, regional, “under the radar” funds do it all the time. But it is not OK.(This is not just for funds. Private companies raising capital must not publicly disclose they are fundraising either, if they want to keep their 506(b) exemption.)So if the fund you are evaluating is “publicly soliciting” you should deeply consider the risks for when the SEC comes knocking.And more widely, remaining compliant with Securities Act rules, Advisor Act rules, state equivalents, and more – not to mention taxes! – is not trivial, and the consequences can be significant. As an investor, you need to be sure the sidecar fund follows the rules – because, if they don’t, ultimately you pay the price.*Descends soap box*Sidecars can quickly go along this progression without good compliance - and you don’t want to be the one thrown overboard.

Whenever you are investing, you should do your due diligence. We’ll skip here all the general diligence you should do every time – team, investment thesis, track records, criminal records, etc. – and focus again on the diligence checklist for evaluating sidecars. So you stay in the right kind of vehicle.Investment decision making: who is making the investment decisions – both according to the legal documents and in practice?Follow-on decisions: ditto. These are often different, but also where more potential for personal agendas, conflicts of interest, or simply emotional decision-making lies. How does the sidecar address them?Fit of investment thesis and sidecar size: does the “lead vehicle” have activity level, scope, capability, and stability to make the investments must to deploy the sidecar? Can it get diversified enough in a reasonable time-frame?Size: while we would all like to see more small funds focused on specific areas, the reality is the costs of setting up funds is not trivial. Is the fund large enough to cover these costs without unduly affecting net returns to investors?Liquidity: what happens when a portfolio company is sold (generally you should get the proceeds immediately); and what happens when you want to exit your position (generally you cannot)?Economics: what are the “economics” of the fund?  Do those providing oversight have “skin in the game” (in the form of their own money)?Does the annual management fee reasonable - enough to cover the costs of the fund but not hurt the net return to investors?Does the carried interest fit market practice (usually 15-20%) and is the amount appropriate to the relative contribution to the success of the fund given by the “oversight” team relative to the passive investors?Do the startup costs seem reasonable? It shouldn’t be that expensive to pay for fund documents, and is it appropriate to charge investors marketing costs for their own fund?Do the fund documents allow for lots of extra ongoing costs to be put on investors (D&O insurance, tax prep costs, …) - and have the managers done that in the past?

We’ll skip the reasons for angel investing in general, as hopefully we’ve covered the potential for making money, having fun, and doing good enough already!The advantages of using a sidecar fund for angel investing include:Passive: early stage investing can be hard work and time consuming. Sidecar funds are designed to be minimal work (for the investor), and are ideal for those without the timeAutomatic diversification:As we’ve mentioned many times before, a single early stage investment is, on average, going to lose money. Diversification is critical. Sidecar funds are designed to create diversified portfolios.For example, VentureSouth Angel Funds I-III invested in 18, 22, and 18-and-counting companies respectively.Smaller exposure and per-deal allocation: angel investing probably requires less capital than you think, but still the total allocation (of say 20 deals at $5,000 per deal - total $100,000) might be more than you are comfortable with. If so, you could significantly reduce it via a $25,000-$50,000 allocation to a sidecar fund.Administrative ease: one set of investing documents to sign, one K-1, and you’re not bothered by ongoing consents or all the other minutiae of early stage deals.

To distill the concepts of the last post into a concrete example: consider a typical VentureSouth angel sidecar fund.It’s a Limited PartnershipIt’s “triggered” to invest when 10 or more VentureSouth members invest, in aggregate, $100,000 or more in an investment. Investments that attract fewer than 10 checks, or 19 x $5,000 checks, do not trigger the fund, so it does not invest.Its match is up to 1:1 of the amount invested by VentureSouth angel group members, up to a maximum investment of $250,000 per company.And the administrative oversight is provided by the VentureSouth central team (as the fund’s General Partner).

After the guesswork of the last post, we’re on firmer ground when discussing how sidecar funds work!First, structurally, they’re usually LLCs or Limited Partnerships, so that investors can pool funds while maintaining the legal liability protections of corporate entities.Second, they generally combine some kind of “trigger” of the fund with a level of “match” investment and some kind of “oversight”.In general, sidecar funds invest when a certain trigger level of investment is received from the driving entity. For example, if the angel group invests $50,000, then the fund is “triggered”.  The parameters for the trigger, and the threshold amounts of the parameters, will vary – but the idea of some kind of automated catalyst for the fund is standard.Some level of match is also pretty ubiquitous to sidecar funds. The approach might vary: perhaps investors want a fixed amount like 20 deals at $250,000 each in a $5M fund (ignoring fees); or perhaps they want to flex with the popularity of the investment, investing from the sidecar 1x the amount invested by the lead group; or some combination of those. We can have fun debates about the best approach, but the common thread is some kind of match.Lastly, oversight. Funds are generally not entirely automatic. It is good to have some human oversight that can help supervise or intervene when life’s inevitable complexity impacts the funds. This “management” can vary from very minimal – perhaps a veto on investments that are technically triggers but aren’t in the fund’s mandate – to more discretionary – perhaps an ability to choose the size of the “matching” investment. The management could be individuals, groups, or a committee; fund investors or outside mangers; and independent or bound by votes of the fund investors. Either way, some oversight is typical.The particular combination of these three elements will tell you a lot about the fund, and might result in substantially different returns.

Data on how the number of sidecar funds are not easy to find.Based on some membership data from the Angel Capital Association, my best guess is that around 10% of angel groups that are part of ACA have a sidecar fund. Groups in the ACA tend to be the larger and more established groups, so the proportion of all collective angel efforts is probably lower. So perhaps 5% of angel groups have one, meaning around 50 in the US?What about in the southeast? As with much in early stage tech funding, the southeast does not lead the pack. However, it’s pleasing to see several groups in the region with a dedicated sidecar fund. Not only does VentureSouth have one (actually several!), there are several university affiliated groups in North Carolina with dedicated sidecar pools from various university and alumni sources, plus others around the Triangle, Atlanta and in Florida.

A sidecar fund is a pooled investment vehicle that makes investments by “riding alongside” another investor.A pooled investment vehicle means an investor puts their money into a common pool with other people.Riding alongside means the pool invests in conjunction with some other investor – an angel group, VC or PE fund, or some other investor.And makes investments is self-explanatory: these funds invest in some kind of assets – in this case, early stage angel investments.This is also a sidecar - but, like sidecars that invest alongside VC funds, or state pools of capital that invest alongside multiple angel groups, we aren’t exploring those in this primer.