General due diligence criteria for fund selection

Fund Managers or General Partners

Perhaps the most important thing to look at when selecting a fund or a VC are the General Partners (GPs). These are the people that you are relying upon to make the investments and choose which will be the next unicorn you are invested in. There are many things that you can search for in a GPs, including:

1. Investment track record
2. Previous funds
3. Successful exits
4. Failed investments and the main reasons for them
5. Location
6. Board of directors and advisors

Most of these are self-explanatory, but we would like to highlight that, in our view, the past investments from the GPs can come from either past funds or private investments. It is not always easy to find accurate information about past investments, but you will always see how the GPs advertise the good (and sometimes the bad) investments. Tools such as Crunchbase or Pitchbook may help in verifying some of the information, although the information is limited. In any case, references will always help when studying GPs.

Another area we would like to focus on is “location”. Nowadays, and with COVID-19 in the midst of disrupting our lives, we still believe that location is important. This becomes a key component when the geography in the investment thesis (as mentioned below) is in areas where you need local expertise (mainly emerging markets). In these cases, we would insist that the GPs have boots on the ground wherever their thesis leads them.

Do have a look at Angel Investor School Day 5, where we have discussed plenty of incredibly interesting regions such as the Middle East, Africa, Israel and Latin America, all of which have their particularities.

Investment thesis

1. 1. Geography
   2. Industry, market and sector
   3. Investment stage
   4. “Secret sauce”
   5. Number of investments
   6. Exit strategy per investment

As discussed in detail with Francisco Coronel, the investment thesis of a fund is of vital importance. As an angel investor, you too should have an investment thesis, but whenever you want to step out of your comfort zone, looking for the right fund that fits whatever you want exposure to starts with reviewing their investment thesis. This will be the one place where you can tell if this is the market, sector, geography, and investment stage you want to have exposure to.

Regarding the investment stage, as an angel investor you will usually be drawn to deploy your angel capital in the first investment stages (pre-seed and seed). However, there is no reason why you shouldn’t aim for better established companies through a fund or vehicle.

Factors such as the “secret sauce” also become very relevant for certain investors and GPs. For example, there is no better angel or investor in marketplaces than Fabrice Grinda. His expertise and knowledge of this sector makes him the go-to person when looking at marketplaces.

Finally, it is important to look at the exit strategy of the fund. Not all are the same as many will look to exit their investments at a certain round in order to provide a specified exposure. For example, a fund may focus on early-stage or pre-seed investments, and have a policy of exiting whenever the startups fundraise at Series A or B. This may be a good strategy as it limits risks and allows for re-investments into other companies. Other funds may have discretion over the exit or hold until IPOs or liquidity events.

Other considerations

1. 1. Potential to co-invest
   2. Potential to participate or add value in the target companies
   3. Size of the fund
   4. Term
   5. Fund’s jurisdiction
   6. Company reports
   7. Responsive administrator
   8. Fund’s governance
   9. Other LPs

There are several other considerations to take into account, especially as an angel investor. We particularly like those funds where the GPs welcome and encourage the LPs to invest alongside them, should they wish to. The companies where the fund has invested will carry a high degree of due diligence and, if they happen to be interesting to yourself or you know the market/sector/geography, it may be an interesting idea to invest alongside the fund and/or engage the with the company to provide advice and become an integral part of them. Many funds will allow for co-investments without any upfront or carry fees (see below), so this is an added value.

The fund’s jurisdiction also plays an important role, as you should research tax and legal implications of investing in a certain location. Nowadays, most funds are established in “friendly” locations, but it’s always a good idea to choose.

Furthermore, you want a responsible fund administrator which will provide timely answers to your questions and periodic updates, so as to review the development of the startups and the investments.

Costs

1. 1. Upfront
   2. Running p.a. Costs
   3. Carry
   4. Reasonable?

Although costs are usually standard, there may be cases where there are significant deviations you should be careful with. A standard fund will have between 1.5% and 2.5% running per annum management fees and there may or may not be placement fees.

Moreover, funds usually have a “carry” percentage. Carried interest, or carry, in finance, is a share of the profits of an investment paid to the GP in excess of the amount that the manager contributes to the partnership. So for example, if the carry is 25% and the fund returns 100% excess the GPs will retain 25% of the profits over and above a hurdle rate, the minimum expected rate of return of an investment, and the LPs will receive 75% of the profits. This, although may sound high, is the main incentive for GPs. Wherever you participate and decide to co-invest alongside the GPs (for the funds that allow this), there is usually no running fees nor carry interest.

Liquidity

Unlike ETFs or Mutual Funds, VC or startup funds do not have much liquidity. You may be able to sell your portion privately (provided the GPs and administrators allow it), but bear in mind that liquidity will usually come from sales or exits that the fund has. Therefore, it is important to note that: (i) your money will likely be locked for a period of several years, and (ii) the fund’s strategy in terms of exits is important and relevant.

Taxes

As with any investment, your capital gains will be subject to tax. It is important to take into consideration tax relief that might be provided by certain funds, such as SEIS and EIS in the United Kingdom. You might also want to consider whether you are investing as an individual or as part of a business organisation.