Successfully launching your enduring venture capital firm is a challenging but incredibly rewarding task. Fund Managers raising their first venture capital fund will have to familiarize themselves with the concept of ‘deal warehousing’ to get to a close. This process involves many tricky intricacies which we will guide you through in this article.
What is Deal Warehousing?
So, what is deal warehousing, you may be asking yourself. Simply put by Richard Gora, Attorney at Gora LLC:
It can be beneficial to warehouse a portfolio of deals and have them in storage when launching a VC fund.
There are essentially two categories of warehouse deals:
(i) The primary type of warehoused deals are companies in which you personally have equity, whether as an angel investor or advisor. You typically incorporate these deals at the stage of fund formation and their value can be used as part of your capital contributions.
(ii) The second are deals that you plan to invest in as a venture capital fund, provided the founder has agreed to hold an allocation for the firm. These deals are done post-closing of the fund after LPs have met their capital contributions.
Benefits of a Deal Warehouse
The primary benefit of warehousing deals is to de-risk the fund by enabling LPs to participate in marked-up deals at lower valuations. Typically, when your personal angel investments (which you’ve moved into the fund) get marked up in future rounds, LPs will reap the benefits of the markup as members of the fund. This in turn de-risks investments into your fund from the LP’s perspective.
Furthermore, warehoused deals are a great signal to LPs of the caliber of your deal-flow and enable you to demonstrate congruence to your pitch and thesis. Having warehoused deals that have been marked up valuations in later rounds which also fit your thesis is an exhibition of your ability to perform as a fund manager.
Court continues to explain the benefits of a deal warehouse from the LPs perspective and says…
“I look at what those companies look like and talk with a few founders to see what really attracted them to this particular manager. I want to see if they have access to deal-flow that I want and but am currently not exposed to.”
Under the Investment Advisers Act of 1940, venture capital fund managers are bound by duties of care and loyalty to the individuals whose money they are managing called “fiduciary duties”. In short, complications can arise when transferring personally held assets into the fund, as it can form conflicts with a fund manager’s Duty of Loyalty, which states that “fund managers must not subordinate their clients’ interests to their own.”
To avoid such complications, it is advised that fund managers do not “cherry-pick” investments from their portfolios when choosing which companies to transfer into the fund. Instead, fund managers should transfer companies based upon the fund thesis which was marketed to limited partners whilst additionally disclosing said risks and conflicts.
Finally, when adding companies into the fund, it is advised that fund managers do not “mark-up” valuations of said companies and instead place them into the fund at cost.
This content is provided by VC Lab, the venture capital accelerator.
The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch over 100 venture capital firms around the world.