My thoughts on Rolling Funds

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Recently, AngelList’s Rolling Fund product has been a frequent topic of discussion within early-stage investing circles. Over the last few weeks, I’ve had dozens of conversations with LP’s and GP’s to get their thoughts on the product.

There have also been some great Rolling Fund articles; Minal Hassan wrote a great early summary here, and Winter Mead penned a very thoughtful and balanced piece from an LP’s perspective in weighing the pros and cons from his perspective.

Before I provide a few of my thoughts on Rolling Funds, here are a couple of refresher points.

- The Rolling Fund product is an evergreen master series LP structure, where each quarter represents a separate “cell”. Less marketed but currently also available, is a traditional venture fund set up through the AngelList platform. For this post, I’m primarily focusing on the former.

- Rolling Fund managers raise funds using the 506(c) provision of the JOBS Act, enabling general solicitation for private securities offerings.

General thoughts:

• Innovation within the venture fund world is rare. Despite being an industry that focuses on backing innovation, very little real invention has occurred in the venture funding ecosystem. However, that seems to be changing as we have seen meaningful innovations over the last 15 years, specifically Y Combinator, First Round Capital, and A16Z. The emerging manager sector has also given rise to models like venture studios and the use of software in investing (Goodwater, SignalFire, Tribe). While it’s too early to predict the scale of significance for Rolling Funds, I’m hard pressed to believe that it won’t be an essential and lasting innovation.
• It’s an excellent alternative for newer managers. However, it won’t displace traditional venture formations: Despite what you may read (particularly on tech/VC twitter), Rolling Funds will not “roll” over conventional venture capital. This chatter is anti-VC rhetoric and unfortunately distracts from what the product’s incremental benefit to the industry. The not so secret truth in venture is the high degree of friction of starting and raising a proof of concept fund, with fundraising acting as the main material friction point. Before Rolling Funds, aspiring venture investors had to go down the singular path of a traditional firm/fund set up, thus signing up to a very long term endeavor (including all the many responsibilities that come pre/during/post raise). Running a venture firm isn’t for everyone, and I’ve met many early managers over the years that decided to pull the plug during or after the fund 0/1 raise because they realized they lacked the passion for running a multiple decade venture firm or didn’t feel they could personally operate financially with the series of small funds they would likely have to settle for before achieving scale in fund size. Rolling Funds allow these individuals to build track records and act as “Super Angels” (remember this term?) before launching firms.
• Rolling funds will accelerate diversity to founders. Despite the renewed interest in backing diverse managers, the number of actual checks written to underrepresented managers by conventional check writers is still lacking. Rolling funds can help aspiring investors in the under-represented category quickly get off the ground and become check writers, thus quickly helping to drive needed diversity to cap tables. The successful ones on the platform can bring the type of momentum necessary for more institutional raises later on.
• AngelList was smart to recognize that emerging venture brands are more often than not a direct reflection of the GP’s personal brand. Several Rolling Funds have launched successfully from managers that have built strong online and offline personal brands. Due to the power of branding online in venture, the product perfectly aligns with the 506c general solicitation rules that allow managers to leverage these same online channels to quickly and continually raise capital. Currently, the Rolling funds I’ve seen and heard about have been mainly raised by those from the tech community, but I would not be surprised the product to be leveraged by strong personal brands in other industries (sports, film, media, etc.).
• Expect higher volatility in return performance. As with traditional venture capital, there will be a large skew in return distribution amongst Rolling Fund managers, with top managers dramatically outpacing the lower performers. I think the lower entry barriers of raising a rolling fund (and the level of experience of many) will result in an even more sizable gap between the top and bottom performing managers. Further complicating things is the unique quarterly model that may result in an LP investing in one quarter having a top-decile outcome and an LP that starts investing in the next quarter getting a bottom-decile outcome. Power law is an immutable truth in venture, and the chance of investing early in a company that achieves a billion-dollar exit is less than 0.5%). This makes the timing of investments critical as the difference between a 3/31 close and a 4/1 close on a deal can materially impact a cohort of LPs’ performance.

Can Rolling Funds scale? Right now, the clear product-market fit for Rolling Funds is proof of concept funds or those that are part-time investors (both of which place the most value on speed and convenience). Can Rolling Funds become a product used by investors looking to raise larger, institutionally run firms? I think a few things will need to be fleshed out, notably:

• The role of LP churn. LP churn likely will be much higher than traditional funds given that Rolling Funds will have predominately high net worth LP bases, many of whom the manager will have no relationship with. Note that traditional venture funds don’t experience much in-fund churn or defaults due to strong incentives that protect against these issues. Churn may also be higher given that the Rolling Fund structure allows LPs to stop backing a manager in a subsequent quarter if they opt to do so.
• The walled garden of preset service providers. Using the platform, AngelList takes care of all of operations, including tax, legal set up, fund admin, etc. This is great “VC in a box” feature, but it’s important to note that many larger LPs prefer that managers use brand name audit/tax/fund admin firms. Additionally, some of these independent third party service point providers offer strategic advice and help that can be very useful to emerging fund managers.
• How will follow-on financings be executed on if LP appetite dries up for the manager in future quarters?
• Whether institutional investors will gain comfort in backing managers on the platform. I think Managers on the system will likely go one of three directions for scale (assuming they continue investing) 1) Continue to perpetually scale AUM through the Rolling Fund evergreen structure 2) Switch to a traditional fund structure on AL 3) Move to a conventional fund structure with hand-selected service providers (although I do think AL will place pricing pressure on these providers). It’s difficult to estimate right now what the %’s will be, or what manager archetype will stay on the platform over time, but it will be interesting to follow.

Having covered emerging venture for the past ten years (and venture as a whole for 20+), I think this is an enormous innovation for the industry. And while I believe there are some “bugs” that give credence to some very well placed concerns relating to potential GP/LP areas of economic misalignment, many of these (and others) are also present in traditional venture capital. I’m personally excited to see how this product evolves over time.