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Should Small Emerging Managers Use Placement Agents?

The pros and cons of choosing a placement agent for small funds

It would make life a lot easier for emerging managers if they could outsource the entire fundraising process. But can you?

Empirically, few small emerging investment managers hire placement agents, particularly in venture capital. And even the firms that hire a placement agent almost always still have to run their own internal process. 

Homebrew doesn’t report hiring a placement agent for their Fund I, despite (or because of) a well-pedigreed team. Greycroft in 2010 also had an experienced team, but didn’t either. Instead, they hired an outside assistant – not a placement agent – to help in the process. 

As Greycroft said in an essay: “Since we were a small fund, it would have been overwhelming to us and our small administrative staff to set up the meetings and follow ups, fill out questionnaires (which for the most part fall into a dark hole), and respond to the myriad of questions which occur during the due diligence process. Although not a placement agent charged with raising the money, this person was an important and critical member of the team and was a key factor in helping us to keep track of where we had been and where we were going – ‘If it’s Tuesday, it must be Belgium.’ ”

Greycroft’s results give you a sense of the complexity involved: The firm said it  had 515 contacts with potential LPs; roughly 250 passed for various reasons and 100 were non-responsive. They had 154 visits, 97 due diligence requests, 33 second visits, and 12 reference requests, to ultimately produce 9 institutional investors. That’s less than a 2% yield of all contacts and 6 percent  of first meetings. In the the end, they reached their hard stop of $130m. Similarly, Elizabeth Yin of Hustle Fund highlights in her blog how she personally completed 345 meetings in a nine-month period for the firm’s first $11.5 million  venture fund.

I’ve worked with a significant number of placement agents and other capital-raising intermediaries of multiple types. Our results ranged dramatically, from no meetings and no dollars, to one intermediary who got us multiple meetings with high-impact investors, a large percentage of which ended up committing. 

There are eight main reasons why so many small emerging managers do not work with placement agents:

  1. Economics. 

Placement agents can usually make very little money on emerging managers, because the dollars involved are relatively small. Carry sounds great, but agents cannot pay the mortgage based on a percent of carry which may not ever emerge, and in any case won’t be liquid for five to 10 years. Typical minimum AUM for a placement agent is $100 million.

  1. Signaling. 

Using a placement agent is sometimes viewed as a negative signal by investors in the capacity-constrained world of emerging managers. LPs tend to assume that the highest-quality managers have all the demand they can handle.

  1. No historical relationship. 

Private equity/venture capital managers have a much longer duration than most any other fund type. Investors, therefore, prefer the longest possible history of knowing a fund manager before they invest. We’ve been much more successful in pitching old rather than new relationships. By definition, placement agents only introduce a fund to new relationships. 

  1. Two degrees of separation. 

In 2018, the 8,000 active private equity funds globally had a 15 to 16 percent  annual performance differential between top and bottom quartile funds. This gap makes the manager selection process relatively more important in this asset class. 

Prabhat Gusain, formerly a manager at Invest India and now an intern with Versatile Venture Capital, observes, “While many large endowments and foundations have adopted the “Yale Model” (in-house staff of 30 professionals to manage a $30 billion endowment), it is uneconomical for those with less than $2 billion. Thus, many LPs have outsourced their investment management processes to professional investment consultants (ICs). Here lies the two degrees of separation: the agent must get to the IC, who in turn must get to the LP. This creates opacity and long-term relationship risk, and makes it harder for the intermediary to add value.”  

  1. Positions your fund as just one option on the menu. 

This is a systemic problem with placement agents. Placement agents have to offer their investor network a range of funds to support themselves. Your fund is one item on the menu, rather than being the only entrée.

  1. Typically less helpful for LPs to talk with intermediaries. 

Many VC LPs are investing not just for returns, but because they want to learn more about the space, get access to co-investment opportunities, network with disrupters, etc. They are less motivated to get on the phone to talk with an intermediary.

  1. Emerging managers are not a commodity, especially in VC.

In general, outsourced salespeople are much better at selling commodities than unique products. That’s one of the reasons I don’t believe that start-ups can outsource sales until they clearly have product-market fit, and even then I typically view it as a core competency that they must build in-house.

VCs are much more heterogeneous, personality-dependent, and harder to assess quantitatively than hedge funds. So, it’s hard for an outsider to accurately represent the sales pitch. 

  1. Opaque industry.

Ha Duong, investment principal at Ocean Investment, a single family office, said to me via email, “It’s extremely hard to identify a good placement agent to work with. In our experience, when trying to select a good partner for a geography we cannot cover, we found it as difficult to get connected to the right agent as getting connected to a strong LP. If you’re just entering a new geography for fundraising, it’s likely you also don’t have the right network to do reference calls for the placement agent.” 

 

All this said, I agree with Samir Kaji, CEO of Allocate, who wrote in The use of Placement Agents for Emerging VC that in certain cases the right placement agent can be extremely value-added. Kaji suggests using a placement agent if they have an LP base orthogonal to yours: “For example, if your network is solely US-based, it may be helpful to have a placement agent specializing in working with European or other offshore LPs.” 

Another option is to use an online investor ecosystem. For example, Backstage Capital recently used Republic to raise $4,856,800 from 7,021 investors in one day. 

Lastly, I’ll highlight that emerging private equity funds are a different ecosystem than VC; it’s much more common for small private equity funds to use a placement agent than small VCs.

If you do decide to pursue a placement agent, I recommend:

  • Most important, make sure your “product” is as attractive as possible. Assemble a quality team and create a compelling narrative. The world’s best salesperson can’t sell a mediocre product.
  • Ask your peer funds for their recommendations for intermediaries or advisors who’ve been valuable for them in their own growth. 
  • Do your diligence. Lots of people present that they have a network of potential investors; only a small subset can actually persuade those investors to write a check.

Further reading:

Disclosure: David is an investor in Republic via HOF Capital.

Previously published at Venture Capital Journal.

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