Many new fund managers ask us, “What is the optimal number of LPs in a VC fund?” Having powered the launch of over 100 VC firms worldwide, we’ve gathered valuable insights into the ideal number of investors for new funds, which we believe to range from 20-30 LPs. Intuitively, one might think that having a vast LP base is always advantageous. However, this may not always be the case, as this article will explore.
We’ve seen a tendency from new fund managers to aim for an extensive base of investors. Unfortunately, this can sometimes work against the GPs and cause burdensome operational and administrative challenges. On the other end of the spectrum, having too few LPs can lead to those investors potentially having unhealthy influence and authority within the fund.
Summary
In the US, having a large base of LPs that exceeds SEC requirements can mean that such funds must register with the SEC. Typically, fund managers avoid registration as it can be a lengthy and complex endeavor. Additionally, fund managers must spend an exuberant amount of time navigating SEC regulations and conducting diligence on each investor with both of these registration exemptions. Consequently, fund managers should aim to have 20 – 30 LPs in their funds to run an efficient fundraising campaign.
Table of Contents
Fund Composition
The composition of LPs in a VC fund is a critical determinant of the fund’s character and operational dynamics. A careful balance must be struck between having too few or too many LPs.
Benefits of Fewer LPs
- Streamlined Communication: Fewer LPs facilitate easier and more effective communication.
- Enhanced Relationships: A smaller group allows for stronger, more personal relationships with each LP.
- Simplified Management: Managing fewer relationships can lead to more efficient fund operations.
Challenges of Fewer LPs
- Higher Dependence: Reliance on fewer LPs can pose risks if one decides to withdraw.
- Limited Fundraising Sources: Reduced sources can impact the fund’s ability to raise sufficient capital.
Advantages of More LPs
- Diversified Investment Base: A larger number of LPs contributes to a more diversified investment base.
- Risk Distribution: The risk is spread across more entities, reducing dependence on any single LP.
- Broader Networking Opportunities: More LPs can mean more networking and business opportunities.
Disadvantages of More LPs
- Complex Coordination: Coordinating with a large number of LPs can be challenging.
- Diluted Relationships: Individual relationships may become less personal and less deep.
- Increased Reporting Burden: More LPs require more reporting and administrative work.
Finding the Right Balance
- Assess Fund Size and Strategy: The ideal number of LPs often correlates with the fund’s size and investment strategy.
- Consider Operational Capacity: Assess the fund’s capacity to manage LP relationships effectively.
- Align with Investment Goals: The number of LPs should align with the fund’s long-term investment goals and objectives.
Opportunity Costs
When fundraising, it can be beneficial for new managers to set forth a clear plan of who they will target and understand the profile of investors they would like within the fund. For more information, refer to VC Lab’s ‘Ultimate Guide to Get LPs,’ which provides helpful suggestions for fundraising.
Too often, new fund managers focus on large institutional investors, which typically do not invest in new GPs or the relatively small funds they manage. At times, new fund managers also concentrate and spend time on investors who wish to invest relatively negligible amounts of capital which causes them to end up with an unnecessarily large LP base.
Combined, both can lead to an inefficient campaign and result in the fund failing to gain traction in its fundraising efforts. As capital allocators, fund managers can also garner an appreciation for the concept of ‘opportunity cost‘ in fundraising. Time spent on the discussed avenues of financing may lead to expending scarce resources and time in an un-optimal manner. Therefore, setting an appropriate ticket threshold can serve to benefit your time and help you focus on the right investors.
Navigating Regulations
It can be provident for new fund managers to brush up on the decrees set forth by local regulators in their jurisdictions. This is because these institutions can often place limitations on the number of LPs funds can have without registering with authorities. Fund managers can strategize their fundraising efforts and develop a thought-out approach using this information. For example, some jurisdictions such as Luxembourg require extensive KYC and AML checks for LPs if they own more than 10% of the Limited Partnership. This can sometimes be a deal-breaker for some LPs as such processes require intrusive background and financial checks.
In the US, the Securities and Exchange Commission (SEC) requires VC funds that seek exemption from registration to follow specific guidelines, including avoiding general solicitation and the following portions within the Investment Company Act of 1940, which venture capital funds typically fall under. Consequently, having a large base of LPs may result in VC funds not gaining exemptions under the following sections in the US:
Section 3(c)(1)
Fund managers that seek exemption from registration via section 3(c)(1) must ensure that the limited partnership consists of less than 100 limited partners for funds over $25m. Recently, the SEC changed regulations regarding the number of investors funds below $10m can have and increased the number to 250 limited partners.
Under this exemption, limited partners must qualify as “accredited investors,” and fund managers must take reasonable steps to ascertain their accreditation status by conducting diligence on each investor. Accredited investor definitions vary with jurisdictions and local regulators; therefore, fund managers should check local decrees. In the US, the SEC, under Rule 501 of Section D, defines accredited investors as persons with a net worth of over $1m (excluding the value of the persons” primary residence) or have a gross income of $200k, or joint spousal gross income of $300k for at least two years in a row. More on accreditation requirements here.
Section 3(c)(7)
To gain SEC registration exemption using Section 3(c)(7), funds must be comprised of “2,000 or fewer” qualified purchasers, where each investor must own $5M or more in investments. Again, fund managers “must” take reasonable steps to ensure each investor’s status as a qualified purchaser.
Administrative Challenges
Taking into consideration the aforementioned regulations, fund managers who have an extensive LP base that exceeds the stated limits will be required to conduct individual diligence on the accreditation status of each investor. As you can imagine this can prove to be an operational challenge, especially when the focus of the fund manager is needed in other critical areas. Upon completing checks, fund managers will also require signatures from every investor to close the fund. Once again a broad LP base can cause friction for GP, who need to orchestrate an efficient process to co-ordinate with all of the LPs.
Operational challenges
After closing, fund managers typically seek to keep investors informed by reporting the portfolio’s performance. Often they also have to manage individual queries regarding the fund and nurture long-term relationships with LPs by reporting on the performance of the investments.
Again, a more extensive LP base may mean that fund managers spend an un-optimal amount of time fulfilling their duties and accommodating LPs. There can be an opportunity cost in these scenarios as managers may not have enough time to evaluate startups, keep up to date with the ecosystem, and write checks on behalf of their investors. The bookkeeping tasks also increase with the LP base and should be taken into consideration by the GPs in the fund.
About The Author
Zander Buteux
Zander Buteux is Head of Growth for Decile Group, powering the next generation of venture capital firms worldwide with an integrated offering of training, tools, support, and funding. Decile Group is the parent of the VC Lab venture capital accelerator, which helped to launch nearly 50% of all new manager firms in 2022.
Prior to joining Decile Group, Zander was at Wilbur Labs, a San Francisco Based startup studio where he was a key operator in the founding of 21 startups across myriad industries. He is eager to optimize and improve the world around him by helping others realize their own opportunities and strengths.
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