What's the difference between a traditional VC fund and an investment syndicate?
The goals of both are to fund and support great startups and make money, but the way money is raised and how deals get done are different.
What’s the difference between a traditional venture capital fund and an investment syndicate (which Deep Ventures currently is)?
I get asked this question a lot.
The goals of both investment structures are to fund and support great startups and make money, but the way money is raised and how deals get done are different.
Let’s dig in.
How Traditional VC funds work
Traditional VC fund managers (I’ll label them “TradVCs”) raise money upfront from fund LPs (limited partners - investors who invest in funds). These TradVCs then scout great startups who are raising a funding round, perform due diligence on these companies, and decide which to invest in.
When TradVCs decide that they’d like to invest, they have determine how much to invest (dependent on how much the startup allows) and write them a check.
TradVCs follow a fee / carry schedule, usually “2 and 20” - 2% fees and 20% carry:
They charge 2% per year of the capital raised for fees (to pay salaries, for fund administration, legal fees, and other costs to keep the lights on)
They receive 20% of the overall profits of the fund (carry)
For example, let’s say a TradVC named Grayson Covington III who graduated from Harvard Business School (legacy, of course) raises $10M for his fund. The lifespan of a VC fund is typically 10 years, and Grayson would charge 2% of $10M per year in fees - $200K per year, equal to $2M over the life of the fund. The remaining $8M is used to make investments.
Now let’s say Grayson is not great at his job and achieves a DPI (Distributed-to-Paid-In) of 1.25x. This means that he was able to turn $10M into $12.5M, for a profit of $2.5M. Grayson then takes 20% of $2.5M, or $500,000, for his carry. The remaining $2M in profit is distributed to his fund LPs.
That’s a simple overview of how traditional VC funds work.
How Syndicates Work
Just like Grayson from above, the Syndicate Lead (let’s call him Mike) scouts great companies, performs due diligence, and decides which startups to invest in. But Mike does not raise money from LPs upfront. Rather, after Mike finds a great startup to invest in, he will pitch said startup to a community of syndicate LPs. Each syndicate LP then decides whether they want to invest in the deal, and how much.
Mike then aggregates all the money from the LPs, delivers the money to the startup, and acts as the central point of communication between the parties. A “special purpose vehicle”, or SPV, is created to finalize the syndicate deal. This process is repeated for each deal.
Fees can vary for SPVs. Depending on the structure of the deal, Syndicate Leads may not receive any fees for finding these deals, only carry (typically in the range of 10-20%). Other times they may charge a fee.
Pros and Cons
These different models have pros and cons for both the VCs and LPs (the experience is pretty much the same for the startup being funded). Let’s start with the VCs.
Pros and Cons for the VCs
Raising Money
Raising money for a traditional VC fund can be really hard. You have to raise multiple millions of dollars from LPs who don’t yet know what companies you’ll invest in. It’s basically a sales process where you need to build high trust in a short amount of time (typically 1-2 years).
With a syndicate, you only have to raise funds on a deal-by-deal basis, and this amount is usually only in the hundreds of thousands of dollars. You still have to build trust with the syndicate LPs you’re raising funds from, but they have information about the company you’re going to invest in, which gives them more confidence in deploying their money.
Autonomy
Because they have raised funds upfront, TradVCs have more autonomy over the startups they invest in and the amount of money to deploy into each.
While Syndicate Leads decide which startups to invest in, they are more dependent on the syndicate LPs on how much to invest. Syndicate Leads need to understand the types of deals their LPs are interested in to ensure that they can invest a meaningful amount of money into a startup. In tough economic times, it can be difficult to complete syndicate investment deals.
Fees
As mentioned earlier, TradVCs charge 2% of committed capital per year to pay salaries and operational costs. This gives them a steady stream of income to invest full time.
Syndicate Leads don’t have this consistent income stream.
There are many other pros and cons for VCs, but these are the major ones.
Pros and Cons for the LPs
Size of monetary commitment
For an LP to invest in a traditional VC fund, they need to commit a large sum of money, typically more than $100K.
Syndicate LPs can invest as little as $1000 into each deal - a much lower bar for entry.
Fees
As mentioned above, traditional VCs charge fees for operating the fund, which comes out of the LP funding. The fees for syndicate deals are much lower, or zero.
Level of involvement
When an LP invests in a traditional VC fund, they are typically passive investors. They wholly delegate the responsibility of investing to the TradVC.
Syndicate LPs are more active. They have flexibility in which startups they’d like to invest in, and how much.
Conclusion
I hope this article helps clarify some of the differences between traditional VC funds and syndicates.
Both structures have their own merits and drawbacks for both VCs and LPs.
In the end, their goals are to fund the most promising startups and make money.
Hope this was helpful. Let me know if you have any questions!