The Role and Relevance of Funds of Funds (FoF) in the Changing Landscape of Venture Capital
Introduction
The background of funds of funds (FoF) can be traced back to a time when limited partners (LPs) sought access to managers they couldn’t support directly. However, with the proliferation of venture funds and a changing landscape, the role of FoF is now being questioned. This article explores the declining trend in fundraising for FoF, the concerns raised by LPs, and the evolving position of FoF in the future of venture capital.
The Decline in Fundraising for Funds of Funds
Fundraising fundraising — the process of raising funds for investment purposes — has been on the decline for funds of funds in recent years. While traditional US venture fundraising reached an all-time high of $162 billion in 2022, US-based VC FoF managed to raise only $400 million in Q1 2023, according to PitchBook. This is a significant drop compared to the peak of $24.4 billion in 2021 and $33.7 billion in 2017.
The decline in fundraising can be attributed to various factors, including:
- The double layer of fees that LPs have to bear, both to the FoF and the underlying commitments made by the FoF manager.
- The additional time it takes for LPs to invest in a FoF and implement their investment strategy, which is something many LPs are currently hesitant to deal with.
- The increasing availability of attractive venture capital funds without the need to go through a FoF.
The Resentment of LPs and the Changing Landscape
Kyle Stanford, a senior business analyst at PitchBook, points out that LPs have resented the FoF strategy due to the double layer of fees and the additional time it takes to implement investments. The landscape of venture capital has also changed significantly, with numerous new companies and funds emerging. This has led to LPs having more opportunities to invest in venture capital without relying on FoF.
Stanford explains, “There have been many more opportunities to invest in a VC than ever before. For new LPs coming into the market, they didn’t need to go to a FoF to get access.”
The Evolving Role and Relevance of Funds of Funds
While the fundraising numbers for FoF have declined, it doesn’t mean that FoF has no place in the future of venture capital. In fact, multiple companies have started to innovate on the FoF model, adapting it to the changing needs of LPs and the market.
Although LPs now have more options to access attractive venture capital funds, there are still certain scenarios where FoF can be beneficial:
- Access to Managers: FoF can still provide LPs with access to managers they wouldn’t otherwise be able to invest in directly. This is particularly valuable when LPs want exposure to specialized sectors or niche markets.
- Diversification: FoF can offer increased diversification by investing in multiple venture capital funds, reducing the risk associated with investing in individual funds.
- Expertise and Due Diligence: FoF managers have the knowledge and expertise to conduct due diligence on potential investments, ensuring LPs make informed decisions without having to do extensive research themselves.
- Support for Emerging Managers: FoF can also play a crucial role in supporting emerging managers who lack a track record or established network. By investing in these managers, FoF can help nurture talent and contribute to innovation in the venture capital industry.
Conclusion
Funds of funds (FoF) have traditionally served as a bridge for LPs to access venture capital managers they couldn’t support directly. However, the landscape of venture capital has changed, and LPs now have more opportunities to invest in attractive funds without relying on FoF. This has led to a decline in fundraising for FoF and raised concerns about the double layer of fees and the time it takes to implement investments.
Nevertheless, FoF still has a place in the future of venture capital, albeit in a different form. The evolving role of FoF focuses on providing access to specialized managers and sectors, diversification, expertise and due diligence, and support for emerging managers. By adapting to the changing needs of LPs and the market, FoF can continue to play a valuable role in the venture capital ecosystem.
Summary: The role of funds of funds (FoF) in the venture capital industry is being questioned in a changing landscape where LPs have more options to invest directly in attractive funds. The decline in fundraising for FoF can be attributed to concerns raised by LPs, such as double layer fees and the time it takes to implement investments. However, FoF still has relevance in the future of venture capital, as it provides access to specialized managers, diversification, expertise and due diligence, and support for emerging managers. Adapting to the changing needs of LPs and the market, FoF continues to have a valuable place in the venture capital ecosystem.
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background of funds (FoF) were created to serve as a bridge for LPs to have access to managers they might not otherwise be able to support. But in an environment where funds are not consistently supported by their existing LPs and there are more venture funds than ever before, is their role still relevant?
Fundraising Fundraiser – Say That Five Times Faster! —has been declining for years. For comparison, traditional US venture fundraising set a record in 2022 at $162 billion. US-based VC FoF raised just $400 million in Q1 2023, according to PitchBook, and $3 billion in 2022. This compares with $24.4 billion in 2021 and $33.7 billion. million, the peak of fundraising, in 2017.
It’s not surprising why many LPs have resented the strategy, said Kyle Stanford, a senior business analyst at PitchBook. For one thing, the sponsors of these funds pay a combination of fees to both the FoF and the underlying commitments that the FoF manager makes.
“LPs have that double layer of fees. And that extra time it takes after [an LP] investing in the fund of funds and then implementing it is something LPs right now just don’t want to deal with,” Stanford told TechCrunch+.
And with so many new companies and funds on the market, the issues surrounding LPs not having access to attractive venture capital funds are largely moot, and that barrier is no longer an issue, he said. “There have been many more opportunities to invest in a VC than ever before,” she said. “For new LPs coming into the market, they didn’t need to go to a fund of funds to get access.”
But to be clear, even if the funding numbers have dropped, FoF still has a place in the future of companies, perhaps just a different one than they traditionally had. Multiple companies have started to innovate on the model, and FoF can still help LPs gain access to managers they can’t otherwise invest in, albeit for different reasons than above.
Fund of funds are starting to play a different role for venture LPs
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