Denice R. Preston
VC and PE funds are typically raised through limited partnerships that have end dates. An open-ended/evergreen structure is a less common alternative. It’s an ongoing fund that continues indefinitely. We discuss open-ended fund nuances with a GP at B37 Ventures who has raised and runs one.
In 2018, I worked on a project with Rodrigo Sanchez, a service of B37 Ventures, for an open-ended fund. These funds are a type of funding that is still relatively unknown, and there is a lack of “in-the-trenches” info about their operation. This article is my attempt to rectify that.
Rodrigo’s experience as a fund manager and entrepreneur of an open-ended VC will be cited throughout this article.
What are open-ended and Evergreen funds?
This is a management company that raises a fixed amount from external investors for a set number of years (typically ten). The management company raises a certain amount of money from external investors through a limited partnership legal structure over some time (usually ten years). The fund closes, the money is invested, and at the end of the process, the fund is repaid.
VC fund structure has remained largely unchanged despite investing in innovative and disruptive industries.
Open-ended funds are the obvious alternative to closed-ended funds. These funds invest capital directly into an LLC on an ongoing basis and without a termination date. This is similar to investing in preferred equity: Investors purchase units of the fund that have a yield attached, called a hurdle rate, and can then buy or sell more whenever they want.
Other names, such as permanent capital vehicle and evergreen funds, can also refer to the fund. Both terms refer to structures that have no fixed capital quotas or end dates. The main difference is that evergreen funds can recycle capital, while open-ended funds (like B37 Ventures) are distributed to investors.
Open-ended Funds: Pros and Cons
Open-ended funds can offer some unique benefits to their investors:
Alignment Managers are able to focus on capital appreciation without being restricted by time constraints. It is also a good fit for entrepreneurs who want to grow their businesses sustainably.
Cleaner Fund Investors can take a longer-term perspective without having to invest constantly.
Flexibility: More flexibility to change investment theories and hold different types of investments.
Transparency: One budget with a set of management costs rather than layers of increasing costs.
Alignment was the key to B37’s decision. Servitje says: “An open-ended structure aligned the most all parties. Our target investors include corporations with sales between $500 million to $20 billion. They are not interested in financial return when they invest in VC. They are looking for strategic returns.
We can provide value to startups by effectively aggregating corporates. The fund is a good idea because all our investors will be equally motivated to evaluate, test, and become large customers for our portfolio on a regular basis. This should yield financial results, which aligns our management team.”
Open-ended funds have their drawbacks. If they were perfect, open-ended funds would be widely used.
Liquidity: The promise of liquidity for investors in an open-ended VC fund may not be a factor. Startups don’t usually pay dividends, and the secondary fund market is small.
Perception Co-investors and startups may not be familiar with the way such funds operate.
Rodrigo, when asked about how B37 is different and will act as a co-investor, draws attention to positive interventions made by its fund in its portfolio. “With any conversation with potential investors, we approach it: This is our track history with our portfolio companies. We don’t speak about the fund’s makeup. We talk instead about the time we spend with corporates to find out their needs and then find startups that can grow in these economies. We are always willing to share examples of our success, case studies, and opportunities that we have seen. Also, we can show what we did with our startups, such as bringing warm sales leads in 12 months after investing.”
How many Evergreen Venture Capital Funds exist?
Pitchbook estimates that the number of evergreen VC funds is around 200, and approximately 100 have been created in the last 20 years. In order to put in perspective how niche these structures are, there are more than 10,000 global investors classified as “Venture Capital.”
To be clear, this number is probably higher than 200 because angel investors, family offices, and corporate venture units are all using this method of investment. These funds are often under the umbrellas of organizations and not disclosed via usual data channels.
Nearly three-quarters of the 92 evergreen VC investors that have been active since 1998 are based in either the USA or the UK. It is not surprising that the USA and UK have the most liquid capital markets, as well as being regarded as hubs for entrepreneurship in their respective territories.
It is not surprising that evergreen VCs invest in software, but it is fascinating to see the rise of the life sciences. It would seem that this sector is a good fit for an evergreen mentality due to the lengthy testing and approval processes undertaken by new technologies.
What are the returns compared to closed-ended funds?
The TVPI (Total value to be paid in ) is a good way to compare the performance of evergreen funds to an overall VC benchmark. As we all know, VCs have irregular distributions of returns. A model doesn’t give a full picture. Even though Evergreens have different mechanics than closed-ended funds, their TVPI returns do not seem to be affected (Pitchbook).
This returns analysis becomes interesting when TVPI is broken down into its components: “Residual Value to Paid In” (RVPI) and “Distributed To Paid In” (DPI). Evergreens have a low DPI but a high RVPI compared with metrics more closely aligned to the VC benchmark.
This shows that the evergreen fund’s long-term strategy can add more value (RVPI) but come at the expense of faster distributions (DPI).
Planning your fundraising can make it less daunting
It must be for a good reason and not just to try something new. You must align your fund with your motivations and ensure that the value it brings to investors and businesses you intend to invest in is also a priority.
An open-ended structure must be compatible with your investment environment or viewpoint. You can, for example:
You are a time-agnostic and believe that the sum is greater than its parts. This belief can be leveraged to create a successful portfolio.
You are in a country with a growing economy where the exit waiting times are longer.
Rodrigo B37 and Rodrigo were attracted to this structure because they believed that startups and large corporations have common interests. “We believe that we have two groups of customers, startups and investors. Our strategy adds value to both. We don’t see ourselves as a traditional fund. Instead, we think of us as a platform where large corporations and startups can exchange innovation and scale. Our investors are mostly large companies with global reach but who need innovation. The best startups are the opposite–innovative but not global; they need scale. “We try to combine those two through investing.”
