Module Description:
Experienced VC allocator/LP Matt Curtolo shares what startup entrepreneurs should know about limited partners (LPs), how VCs relate to LPs, and how entrepreneurs fit into this capital ecosystem.
Full Transcript:
- Welcome, everyone to our Ubiquity University session. LP 101: What entrepreneurs need to know about LPs. Today, we're lucky to have Matt Curtolo, experienced venture capital allocator with over 20 years of experience, including institutions large and small, most recently, Allocate. Ubiquity Ventures is a seed stage venture capital firm investing in software be on the screen, we back entrepreneurs who are bringing software off of computers into the real physical world to solve real world business problems. Today, we're excited to pull back the curtain in this three part series and we'll start with what entrepreneurs really should know about LPs. Matt, it's been a pleasure working with you so far and thank you again for volunteering to do this series and pull back the curtains, I'll ask you to take it away.
Yeah, thanks, Sunil. Likewise, been a pleasure working with you in the past, and this is really exciting because I spend a lot of time talking to folks having been an LP in a lot of different organizations over the last 20 years. So, you know, I think demystifying the role of the LP from a lot of different lenses is where we should start. And first, when you think about the entrepreneur and the LP, in a lot of cases, they're not necessarily seeing and talking to each other on a regular basis. So it's important to kind of bridge that gap a little bit. So, I think first place to start is what is an LP, right? In a lot of cases we throw around jargon in the business without necessarily providing enough background and context expecting everybody to know these things. So, what is an LP? So an LP in the legal construct of what most partnerships are, limited partnership, they are the limited partner. What that means in practicality is they are the source of capital for the funds that are being raised by the venture capital, by the firm. So this can be different forms, whether that be institutional, individual, that might be a high net worth individual, an institution like a pension fund. We'll talk a little bit more about this and how those kind of differ. But think of the LP as the capital source for the GP. The GP sometimes called the fund manager or the investor. In that case, the GP is the one responsible for investing the capital provided by the LP. There's a fiduciary relationship there in terms of trust, in terms of governance, what they're supposed to do in terms of executing against a stated strategy. But the GP is the person effectively involved and in charge of the management and the investment of those dollars.
And Matt, let me chime in here a distinction that maybe it's a little crude, but the LP, the GP, one letter difference. But that letter is a world of difference in my experience, LPs make one decision, which is whether to invest or not. And then at that point onwards, the GP makes all the other decisions about which companies whether to invest, how much to invest, whether to sell. So it's a huge align between the two worlds.
Absolutely, and I think it does speak to, Sunil to the conversations that need to happen over time, the LP we'll talk a little bit more about this in future sessions, but the communication between those two parties for sure. So, I thought what would be most interesting from an entrepreneur's lens is just understanding the flow of dollars. So, we talked about the types of LPs so that you can see kind of in the middle of this chain, there's the LP investing entity that's effectively the group who's going to be putting the dollars with the GP, the venture fund. But when you think of certain types of these LP investing entities, particularly from an institutional perspective, I'll use a public pension for example. California has the largest public pension in the country known as CalPERS, California Public Employees Retirement System. So what that is, is a collection of a small piece of every public employee's paycheck goes into that pension. And CalPERS is in charge of investing those dollars into a variety of different asset classes. Not just venture capital, but really they are the fiduciary, they're the responsible party to hopefully generate a return. So those public employees can have a pension at some point. So when you think about the capital flow, so those pension dollars go into a large organization, that group generally has a team that's going to review what makes sense from a top down portfolio asset allocation perspective. The next layer down of how do we wanna invest in a public market, you can think about passive investing, investing in indices or investing in the whole market. Or you can think about active management, which is investing in managers who are then going and executing a strategy. In venture capital, there is no real way to invest in the asset class passively. So it's all about picking managers. So that team is going out there, maybe team individuals, a third party maybe going out there to source the managers. So you're boiling the ocean to some degree. There are roughly 4,000 venture capital firms in the world now. So there's a lot of options. But that pension fund is going to select that fund, that GP and provide them capital from that large pool with the expectation that that fund manager is gonna execute a strategy that will hopefully generate an adequate level of return that that LP investing entity is seeking. So when you think about them, those dollars have flowed to the fund, that fund has stated investment strategy. They're not just generally gonna invest in one company. They're gonna invest in a portfolio of companies. So that's where you see the label here, portfolio company that is just each individual company that the VC or the firm is going to be investing in. So let's say for example, a strategy might have 20 different portfolio companies. So that fund is providing, let's say it's an even split one 20th of that capital into that portfolio company. Ultimately, that portfolio company is represented by a founder, by an entrepreneur, by a founding team. So some percentage of that enterprise value, that equity is gonna flow all the way down to that entrepreneur, hopefully becomes a big dollar amount when that company gets sold or acquire or has a massive exit. Everybody is hoping for that along this value chain 'cause if you think about how it works in reverse, that company produces a great outcome. Some of those dollars flow back to the GP. The GP then makes a distribution back to the LP investing entity, which ultimately goes back into those pensioners check that they'll get when they retire. So, I think it's important to understand both up and downstream. And the other thing I would say is if you pull any of these pieces out of this pipeline, in some cases you don't have constituents. It may not be a large group rolling up into one single entity. But any other part of that, that value system would really upset kind of any of this process.
Matt, I'll add a fun wrinkle. This looks like there's a left side and the right side, but sometimes the right side founders, maybe you went to university and got a scholarship. That scholarship comes from the university endowment that's an LP in funds. Or you have a pension and so you can be on both sides of this. So it is actually a circle of life in some respect.
You know what Sunil, I did struggle with, is this a really, it's a continuum 'cause you can look at it both left and right, but then you can also look at it in that circular context. So, great. So, putting that into the context of, you know, an LP is giving capital to the VC, the GP, the fund to be able to go out and invest those dollars. So, the average VC fund, there's a term, there is a fund life in the documents anytime a VC fund is formed. That's generally 10 years, there are extensions in there. So think of it as 10 plus years for that fund to really go full cycle to go from the day of its inception, the first investments that it's making, to ultimately at some point that fund has to wind down and liquidate and sell all the assets in there. There is a finite life for these funds. Now, overly on top of that, an investment period, so the early years of the fund is when the GP is going out and finding investments, investing in you, the entrepreneur and your company. That's gonna be in the first two to four years of that process. So throughout that process, the, the GP is, let's just take those two separately. The GP is investing in companies over those first two to four years. That fund, basically, the outcomes are not gonna be decided until, you know, maybe three times longer, 10, 12 plus years. But in the interim, the GP is really trying to build a firm and a franchise. So they're gonna have to go back to those LPs and raise new capital to continue executing the strategy. So that means that the VC's gonna have to go back and ask for more capital, ask for a new commitment from those investors and new investors. And really the average LP is dealing with several hundred potentially investments that they have across this table. So, what I hone in here on is you as the entrepreneur, the progress that you're making in your company is gonna be an important catalyst in the GPS fundraising process going back to LPs, showing them that their strategy is working. And so I really do wanna just talk about the role of the entrepreneur in this whole fundraising process. The first one I just alluded to, you're building a company, go out and execute, drive results and progress. I frame it here a little bit in the hierarchy of bosses and bosses bosses, but the VC who sits on your board who provided you capital, you're answering back to them. They're answering back to the LPs who provided them capital. So, the opportunity for you to just continue to execute at a high level really shows well as that information travels up the chain back to those bosses and bosses bosses. The other piece of that is the communication. As an LP, you know, we're generally getting communication once a quarter from managers, sometimes a little bit more frequent, but we're not in the weeds given the volume of investments that most LPs have. So what you can do is be as clear as possible in terms of delivering both financial and overall progress to your VC. So they can then organize and collate and bring that back to the LPs in a clear and concise way. So making sure that communication channel is as clear as possible to make your VC's job as easy as possible as well to deliver that back. So, do your job, communicate that clearly that those seem like very simple things, but those do make certainly the pipeline and the value chain increase in efficacy as it gets back to raising new capital, having that next fund, helping your VC continue to build a franchise. The the last piece here I think is equally as important, it's slightly different, but during these fundraising processes for VCs as LPs are doing their due diligence and their underwriting of the fund manager, we always ask our VCs for references. So that may be other LPs who've invested, other GPs who may have invested in the same companies, co-investors or in most cases what I love to talk to is the entrepreneurs themselves. So this is really one of the few opportunities that the LP and the entrepreneur connect directly outside of maybe an annual meeting where all the constituents get together in one place. But assuming that the VC's doing a great job for you and you're happy with the outcome and all the support that you're getting evangelize, really tell that story. Be as confident and clear as possible when you're conveying that message back to the LP. Granted, I would say don't lie about this. The LP is gonna do a lot of these references, if yours is very off base or it doesn't mesh, this is one part of a mosaic as the investment process. But what I would really say is give specific examples of how this group helped you, how the VC was able to, you know, help your business get from point A to point B where they've added value. Why did you pick them? How have they been as a partner? So all of these things, it's a very qualitative asset class to invest in. When we are investing as LPs into funds, those funds are blind pools. So we're really trusting in people in process and ultimately using some of those data points from history to get a lens into how this might be in the future. And your response to questions around how the experience has been will go a long way in shaping the opportunity to, you know, help promote that GP into, you know, the next fund, the next franchise.
Perfect. Well, Matt, this is a quick and thorough, I should say quick yet thorough introduction to what entrepreneurs should know about LPs. It does seem like they're worlds apart, but they do crisscross a lot. And I think understanding the mindset and the potential interactions is really helpful. So thank you for doing this session. This has been our Ubiquity University session on what entrepreneurs need to know about LPs. Again, Ubiquity Ventures, we'd love to hear from you, especially if you have an idea that ties the software, be on the screen, set up a meeting at pitch.ubiquity.vc or if you'd like to get in touch with me, I'm Sunil at Sunil@Ubiquity.vc. So, thank you again, Matt and we'll continue this in our next session.
Thanks, Sunil.