Finding funds that are willing to collaborate and engage with their limited partners is one of several pieces of advice for fund-of-fund investing.

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Corporates venture funds not only make direct investments themselves in startups, but sometimes they invest in other VC funds — so-called fund-of-fund investments. It is very common — the GCV Keystone annual survey of corporate venture units last year found that 56% of corporate venture teams take LP positions in other funds.

Sometimes new CVC units use this as a learning strategy — getting a feel for investing and the startup ecosystem. But it is not just newbies that use LP positions. In fact, it was more common for CVC units that were more than three years old to do this than it was for younger ones, and it was more common the bigger a fund was. Among the CVC funds with more than $1bn in assets under management, some 80% had LP positions in other funds.

So why do even highly experienced corporate investors use this as a strategy? What do they get out of the relationship? And most importantly — what does a corporate investment team planning to use a fund-of-funds strategy need to do to get the most benefit from the arrangement?

Our recent webinar “Investing in funds and making the most of strategic LP positions” brought together a panel of four experts with different perspectives on this. Chihiro Hosoya, head of the Rx+ Open Business Creation division of Japanese pharmaceuticals company Astellas Pharma, and George Kellerman, managing director at Toyota’s investment unit Woven Capital, both have active strategies to take LP positions in other funds. Meanwhile, representing the other side of the equation, the funds with LP investors were John Banta, president and GP of Blue Venture Fund, which has 36 companies in the Blue Cross Blue Shield family healthcare insurance companies as backers, and Katie McClain, partner and COO at Energize Capital, which has 12 corporates from a variety of different sectors as LPs.

Why CVC units take LP positions in other funds

There are two chief reasons for a fund-of-funds strategy: the getting access to specific expertise and covering more ground geographically. LP positions could also be a financial hedging tool or be used when a team doesn’t feel it can fully commit to direct investments.

1. Expertise

Astellas Pharma, for example, has a CVC unit that invests directly in biopharma startups, an area in which it has plenty of expertise. But when Hosoya’s team wanted to invest in non-core, non-pharmaceuticals companies, they felt they needed to tap into an a different knowledge base.

“We don’t have the expertise to select the right investments and support the portfolio companies. We wanted to work together with the VC funds, who already have domain expertise in specialised fields like medical devices and digital,” she says.

Kellerman at Woven Capital, meanwhile, is mainly investing directly in startups but dedicated 10% of Woven’s $800m fund to investments in other funds. He has taken nine LP positions so far, mainly in specialists funds — one dedicated to cybersecurity, for example, and another focused on logistics and the supply chain.

As Kellerman puts it, investing through a specialist fund can save companies a lot of time — they don’t have to learn the ropes of a new area themselves.

“Our thinking was [that a sector expert fund] going to meet 1,000 companies in that sector alone over the course of a year. They’re going to know who the leading companies are and how they’re doing,” he says. “If we’re looking at it company in that particular sector, we could go to them and ask: ‘Hey, what do you think of this company? Have you heard anything about them?’ And in some cases, we’ve actually done that. And they said, ‘Yeah, we looked at them two years ago, we decided to pass and here’s why we decided to pass’.”

2. Geographic coverage

Kellerman set up Woven Capital during the Covid-19 pandemic when it was difficult to hire people and get them to relocate to Japan. Investing in other funds was a way of being able to access deals in other countries more easily. But even without Covid as a factor, he would have done the same.

“We never would have been able to cover the number of startups by ourselves. It really became a force multiplier for us,” says Kellerman.

“We wanted to make sure that we were covering all the major markets. But we weren’t necessarily going to have somebody on the ground in [each] market. A really good example is Israel. We’re an investor in a fund in Israel, but we didn’t anticipate that we would actually have staff on the ground there.”

3. To make returns

Unlike VCs, corporates rarely invest just for a financial return. But it is wise for a corporate venture unit to ensure a certain level of financial performance and taking LP positions in other funds can be a good way to hedge bets.

Kellerman says it’s a nice side benefit to the fund-of-funds strategy. “Because we invested in nine funds across multiple geographies and multiple industry sectors, we actually have very good diversification in our portfolio. Our returns aren’t likely to be huge, but we’re not likely to lose money either. I like to think across the portfolio, we’re going to make good financial returns.”

4. To avoid ruining your reputation

When a corporation isn’t ready yet to move quite as fast as regular VCs in investing in the startup ecosystem, it can be better to stay one step removed and let someone else handle the deals.

“I’ve learned it’s very difficult to be able to support a portfolio company. Startups need money yesterday, but our corporate decisions can take four weeks — it doesn’t really match,” says Hosoya. The risk is that a slow or indecisive corporate ends up simply annoying the community it wants to become familiar with. “It may actually be harmful to just play around with making direct investment efforts,” she says. It is better in these cases to let a VC fund handle to deals.

Investors get value out of their corporate limited partners too

“We work closely with our corporate LPs and consider the knowledge that we get from them to be part of our differentiation in the market,” says McClain. “So, our corporate LPs play a huge role in helping us both with our investment thesis and diligence, and then also often become customers of our portfolio companies.”

Corporates that start as simply LPs can become coinvestors and collaborators further down the road, says Banta. Some 10 years back, he says, not many of the Blue Cross and Blue Shield companies had their own investment efforts. Even taking an LP stake in the Blue Venture Fund was a bit of an experiment. But now things have changed.

“More than half of them now have their own direct investment programs. And they’ve realised this is an extension of the bandwidth for those teams. This is a tremendous resource they can leverage, and it supports their corporate development efforts. So, I’d say 30 or 40% of the time we’re coinvesting with them.”

How to get the most value out of the LP arrangement

Benefits from taking an LP position in a fund don’t come automatically, however. Here are some tips from our panel on how to make the relationship work:

1. Look for funds that are willing to engage and collaborate with their LPs

“That was actually one of our decision-making criteria,” says Kellerman. “The fund had to be willing to collaborate and cooperate with us. We wanted to make sure that there was a commitment.” Kellerman says this was easy in most cases as VCs were often very keen for their portfolio companies to have access to Toyota.

2. Corporate investors also need to be willing to engage

“We’re looking for that similar engagement on the other side of the fence,” says McClain. “We want make sure that the corporates are engaged and are serious about it as well. We want to have someone who knows how to navigate the [corporate] bureaucracy, how to get to the right business units, make sure that the pilots are worth the startups’ time and energy and resources.”

3. Don’t get overwhelmed — hire a dedicated person to manage the interaction

“I could go back, I would make sure we had a dedicated person just to manage our fund-of-funds investments,” says Kellerman. “We get so much inbound information from them. With some of them we have monthly meetings, some of them are constantly sending us potential deal flow. Just having somebody who can manage that on our side is valuable.”

Speaking from the other side, Banta says he sometimes sees corporate LPs unable to handle too much contact from the fund. “You can easily become tiresome and overwhelm them with efforts to get them to engage. You have to very mindful about what fits what cadence and what style of interaction fits with each LP. It requires a little bit of dedicated effort,” he says.

4. Consider a secondment — but only for a short time

A secondment is something Hosoya tried back in 2016 when Astellas first started looking at digital health investments. Hosoya was seconded to the digital health fund that Astellas invested in with the goal of learning something about the market and the investment process.

Hosoya says the exercise was useful but says secondments should be kept short. “Working at the VC for a short term period has an educational purpose but it doesn’t fit in a long term,” she says. Seconded can get lost — they aren’t employed by the VC but can lose sight of their own company objectives. The best way to do this is to start with someone full time at the VC, but then gradually decrease the amount of time they spend there.

5. Invest enough to get the rights you want

The fact is that the more you invest, the more decision-making power and information you will get. McClain says investors in Energize Capital tend to invest somewhere in the range of between $5m and $15m each.

“If you are a $15m investor, then you’ll get to sit on our on LP advisory council. And if you’re a $5m investor, then we’ll kind of come up with a more curated programme, monthly or quarterly calls,” she says.

Both Kellerman and Hosoya say they think about cheque size strategically in this way. “We look at what is required to get the benefits that we want relative to other LPs in the fund,” says Hosoya. Kellerman does the same. Keen to have a very wide spread of LP positions, he tends to invest at the low end of the scale, between $5m and $8m per fund investment. But in one case where the team specifically wanted to have a high level of rights, he was happy to double this commitment size.

6. Think about a side letter — but you probably don’t need it

Side letters — written agreements between a fund and its LP specifying rights, privileges and obligations outside the standard limited partnership agreement— are one way that a corporate investor can try to guarantee it gets the rights it wants from a fund. Kellerman, for example, tries to have a side letter with all Woven Capital’s LP positions.

McClain says the most common request she gets from corporates is not to be in the same fund as their rivals. “Some of our LPs have ‘a do not invest’-list of their four or five top competitors,” she says. McClain is generally happy to comply, picking investors from a variety of industries for the fund.

But other kinds of rights stipulations are probably not necessary, says Banta. ”We’re on fund five and we’ve never had a side letter,” he says. “The general partners that tend to thrive and survive are optimising around maximising this kind of engagement, so it’s not really a case of having to have terms inside letters to compel engagement.”

7. LP investments are a long-term relationship. You might want to invest more than once. Budget accordingly

One regret that Kellerman has is that he made all of his fund-of-fund investments quickly and did not budget for investing in later funds raised by those same teams.

“My thinking was, let’s get our fund-of-fund investments out of the way as quickly as possible in year one, if possible, year two at the latest,” he says. “But what I didn’t realise, and I regret that I didn’t plan for this, was that some of those funds were going to run through their funds in two years or three years. And they were going to be raising another fund and their expectation was that we would come into their next fund. And I wish I had. If I could go back and do it over, I would have allocated funds simply to go into later funds,” he says.

It might seem that investing in a VC team’s second or third fund is a bit of an academic exercise if there is already a relationship through a first fund. But not being in a specific fund can limit your access to information, says Banta.

“When you’re not in the active fund, you’re not getting access to the current sourcing that’s going on. That’s one of the more valuable aspects of being involved with a GP team has — to see what the current state of play is and what the current state of the innovation landscape is and what the current sourcing events are that are going on,” he says. “For confidential and other reasons you’re not going to have access to that if you’re in the prior vintages and not in the current vintage.”

Watch the full replay here:


This webinar is part of GCV’s The Next Wave series of webinars. We run a webinar on the second Wednesday or every month, alternating between advice for CVC practitioners and deep dives into specific investment areas. Our next webinar will be Functional Food: Investors are hungry for more on October 11, 2023. Register here to secure your place.

Maija Palmer

Maija Palmer is editor of Global Venturing and puts together the weekly email newsletter (sign up here for free).