Brief

Fund GPs and Syndicate leads undertake a broad scope of activities in addition to investing, such as fundraising, deploying capital and managing returns. They are compensated with fees and carried interest.

While these activities are common to both, there are differences in dynamics for Fund GPs and Syndicate leads.

1. Capital Availability: VC Funds have a defined capital pool following the completion of fundraising. This can be a prolonged process taking a year or more.
   
   Syndicate capital is a function of the investor network, how engaged LPs are, and their cheque size. Instead of fundraising ahead of time, syndicate leads raise capital from LPs on each deal.
   
   
2. Capital Allocation: The GPs of VC funds make capital allocation decisions on behalf of fund LPs.
   
   Syndicate leads make portfolio decisions through their deal by sourcing and diligence recommendations. LPs control the decision on whether or not to invest, and how much. In this way, syndicate leads construct the portfolio while LPs make capital allocation decisions.
   
   
3. Investment Scope and Flexibility: VC funds have an investment scope that is determined by their fund mandate. They may not invest outside of this thesis unless they raise a new fund which is a long, demanding process.
   
   Syndicate leads can propose any investment to their LPs. This allows syndicates greater flexibility in what they invest in.
   
   
4. Economics: VC funds typically have 2/20 compensation structure, and a return hurdle. Carried interest is calculated on the portfolio level.
   
   Syndicates charge an upfront management fee and vary on carried interest. Angel School uses 2.5% management fee (one time non-recurring) and 20% carry. Carried interest is also calculated on a deal by deal basis. This gives syndicate leads a profit advantage over VC fund GPs in terms of carry.

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Relevant reading:

• Why Syndicates are more profitable than Funds
• Building an Angel Syndicate: Implications for Syndicate leads
• Angel School Ultimate Glossary of VC terms

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Introduction

Fund GPs and Syndicate leads have to execute a broad scope of activities alongside the primary task of investing. This includes fundraising, picking companies to invest in, deploying capital and managing returns.

While these activities are common to both, the dynamics can be very different. Some are intuitive. For example, startups may favor VC financing over Angel syndicates. This can offer VCs an advantage in deal access over syndicates. On the other hand, the profitability advantage of Syndicate carried interest over funds is less commonly discussed (we examine this specific topic in this article on Syndicate Profitability Over VC Funds).

Key Dynamics for VC Funds and Angel Syndicates: This article discusses the 4 ways that VC funds and syndicates differ for the fund GP or Syndicate lead. There are 4 key dynamics that affect VC Funds and Angel Syndicates. They are:

1. Capital Availability: How the fund or syndicate receives a pool of capital to invest?
2. Capital Allocation: Which companies are invested in? How much capital is given to each company?
3. Investment Scope and Flexibility: Which companies can the fund or syndicate invest in? 
4. Economics: What management fees and carried interest do GPs receive?

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Capital Availability

VC Funds and Syndicate Leads receive capital to invest into a portfolio of startups in very different ways.

VC Funds:  

• VC Funds raise capital by promoting their fund to Limited Partner investors (LPs) who commit ahead of time how much they will invest in the fund during its lifetime. In this way, a VC fund will know with a high degree of certainty how much capital it has to invest ahead of time.
• b) Fundraising is a demanding and time consuming effort, requiring GPs to meet with LPs to pitch their fund, explain their investment thesis, and show a track record. This can take a year or more. It is especially difficult for first-time or lesser known fund managers ; in a previous article, we make the argument that first-time fund managers should invest via a syndicate before a fund. The minimum cheque for a fund LP can be $250,000 for a small fund and as high as $MNs.

Syndicates:

Syndicates are backed by an informal group of investors who can be Angel investors, family offices and other VC firms. LPs decide on investment opportunities as they receive them from the Syndicate lead. In this way, syndicates do not have a prolonged fundraising before being able to invest and instead, raise capital on each deal.

Therefore, a syndicate’s capital pool is unknown ahead of time. Capital availability is a function of the number of LPs in the syndicate network, how engaged they are to the syndicate’s deal flow, and their average investment size. Active syndicate networks also grows over time as new LPs join the network. While unknown ahead of time, Syndicates therefore grow their capital pool.  

The more LPs a syndicate has, the more engaged they are to that source of deal flow and the higher their cheque sizes, the greater a syndicate’s capital availability.

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Capital Allocation

Syndicates and VC Funds vary in terms of how capital allocation decisions are made in each portfolio company.

VC Funds:  

Funds are a largely passive investment vehicle. LPs entrust the fund manager to find and select the right companies to invest in. 

Fund LPs also control capital allocation decisions. They decide how much to invest in each company, and how much to withhold for follow-on investments in future.

Syndicates:

Syndicates are a more active investment vehicle for investors. Syndicate leads control portfolio selection through deal sourcing, diligence and making investment recommendations to LPs. 

LPs actively participate in this process by studying the company and reviewing information. Syndicate LPs ultimately control 2 decisions: (i) whether or not to invest, and (ii) how much to invest. 

In this way, syndicate leads control portfolio construction, while syndicate LPs control capital allocation decisions.

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Investment Flexibility and Scope

Syndicates and VC Funds have different governance on what they’re allowed to invest in.

VC Funds:  

VC Funds have a set investment thesis, mandate, and risk control mechanisms defined. They are bound by these restrictions which can be especially restrictive for new fund managers without an established track record.

VC Funds can switch their investment scope by raising a new fund with a new thesis. This is slow and cumbersome given the prolonged fundraising time. 

Syndicates:

Syndicate leads can theoretically invest in any company they deem worthy of receiving it. They simply have to ‘make the market’ by building a convincing argument to their LPs that they should invest.

We firmly believe that all investors should invest based on a disciplined thesis. That said, the ability for a syndicate to pivot to new sectors or pursue opportunistic investments offers a greater degree of flexibility.

‍GP Economics

Syndicates and Fund GPs are compensated on a combination of management fees and carried interest. There is a greater degree of variability for syndicates which make it hard to sustain as a full time endeavour.

VC Funds:

VC Funds generally conform to a 2/20 model. LPs pay 2% of committed capital each year during the fund’s life in management fees. They also pay 20% in carried interest- essentially receiving 20% of profits generated by the investment portfolio.

VC funds also have a return hurdle applied before GPs receive carried interest. This compensates LPs for the cost of capital. A typical hurdle is 7% / yr. Compounded over 10 years, the fund needs to return LPs 196% of their original capital before carried interest applies.

Another key difference is that carried interest in a VC fund is calculated on the entire portfolio. Investments that return less than their original investments incur a loss which drags down portfolio profit and therefore, impacts GP carry. 

Syndicates:

Syndicates vary a lot in their economic structures; some may not charge management fees or charge carried interest less than 20%. For the purposes of this article, we use Angel School’s standard practice: 2.5% one-time management fee and 20% carry.

Syndicates do not apply a return hurdle.

Syndicate carry is also applied on a deal-by-deal basis. Investment positions that do not turn a profit generates 0 in carry. This loss does not the profit from other investments. Combined with the lack of a return hurdle, the profit advantage of syndicates can be very significant (we examine this specific topic in this article on Syndicate Profitability Over VC Funds).

Conclusion

In this article, we examined 4 dynamics in the operation of a VC fund or syndicate, and how they affect the fund or syndicate vehicle differently.

They affect fund GPs and Syndicate Leads differently and are worth understanding.

In our next article, we discuss these implications from the perspective of a Syndicate lead.

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Other reading:

• Building an Angel Syndicate: Implications for Syndicate leads
• Why Syndicates are more profitable than Funds
• Angel School Ultimate Glossary of VC terms

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