Defining Today’s Opportunities Funds

Top Tier has observed a growing number of funds titled as “Opportunities” Funds in the ecosystem, which can mean many different things. We are continually having to define these fund names internally so we have accurate context, and thought it would be helpful to share our naming conventions which are based on the underlying investment strategy. While many have come to think of these funds as “Growth” stage vehicles, the nuances are important to note when defining these side pools of capital that are available in the ecosystem. GPs with demonstrated access to high-quality deals have long been raising more and more capital in these sidecar pools, which are often referred to as Opportunities Funds. Admittedly, Top Tier has fallen into the Opps Fund naming convention and we’re happy to unpack why we have one too!

First, let’s define the overarching principles of an Opps Fund:

  • Generally, a different, but related strategy from the Core Funds that a firm raises:
    • i.e., an early-stage fund will raise a later-stage focused Opps Fund and a later-stage firm might raise an early-stage fund (or, more likely, an even later-stage focused fund).
    • This is important as there are typically limitations on raising subsequent investment vehicles without existing LP approval, if the strategy is the same. While GPs typically obtain approval from the LPAC’s for this fund (and often times, they invest), it’s not always necessary, depending on the fund strategy and structure of the LPA.
  • Initially marketed as an unproven strategy for the firm, but GPs show there have been example “opportunities” where the firm has had unique access to attractive allocations in the ecosystem:
    • i.e., the discussion and analysis centers on: If I had followed on/invested into XYZ rounds of these companies we knew really well, we could have made $$$.
    • LPs and GPs both consider whether these are point-in-time macro and micro opportunities, or a shift in the ecosystem. Ultimately, performance of these vehicles will define the longevity of the strategy on the platform.
  • Usually the same general team and a smaller percent of AUM:
    • Typically, there is an “emotional lead” from the GP ranks who will be responsible for the new strategy and making sure that all investments meet the existing bar of quality.
    • While the investment “opportunity” might actually be larger at that stage, the firm typically will raise less money for this strategy as compared to its Core Funds. 
    • As the activity matures, the firm may build a team around the strategy and raise larger amounts of capital.
  • Typically, lower economics than the Core Fund:
    • Both the management fee and carry incentives are generally lower on these vehicles, as the expectation is that the Core Funds are the “crown jewel” on each platform and the fees/carry from those funds help pay for the new strategies to get it off the ground.
  • Core Funds “eat first”:
    • Allocation policies around these funds are usually contractually explicit in the LPA, as LPs (and the SEC!) need to understand which funds have priority for a certain type of investment.
    • If it’s a follow-on type vehicle, then the Core Funds usually have some sort of concentration limit or valuation where additional capacity shifts to the sidecar vehicles. 
    • Most of this is up to GP discretion, but consistency is generally the best policy.

Types of Opps Fund strategies we see (and the terminology we use to name them):

  • Select Fund – reserved for follow-on rounds in existing portfolio companies for a firm; generally does not price financings, and fills the pro rata available to its other funds in subsequent rounds after the Core Funds’ reserves are exhausted.
    • Generally, the most successful strategy we’ve identified to date.
    • Most are concentrated in a few companies.
    • Very hot right now with many early-stage managers raising Select Funds to fill late- stage pro rata.
  • Growth Fund – capital focused on later-stage companies that are not a part of the existing portfolio; generally trying to lead financings and will price rounds:
    • While this is a core strategy for a number of firms (and a historically successful one at that), when these are Opps Funds, they are typically referring to companies they have been tracking for potential investment by the early-stage fund, but for one reason or another, either decided not to invest or did not receive an allocation during that round.
  • Concentration Fund – This is what historically would be considered a “Parallel” Fund, as the idea is to have a pool of capital that would limit the overexposure of certain assets in the core portfolio; these are generally focused on the highest conviction bets by a firm and invest in the same initial round as the Core Fund.
    • i.e., the firm received a $30M allocation in a Series A to a hot company, but that would be too large of a check for the Core Fund, so they might put the extra allocation in a Concentration Fund.
  • Scout Fund – An early-stage focused fund meant to provide deal flow for the core portfolio, this is typically structured as an allocation by the main fund for this strategy, but we have seen examples of this as a separate vehicle.

     

  • Leaders Fund – very late-stage venture companies demonstrating best-in-class metrics,  possibly from the existing portfolio or external companies. Underwritten returns are typically targeting 2-3x net and expect lower risk profiles.

     

  • Crossover Fund – as companies are going public, they typically raise a private round of financings 6-9 months before filing for an IPO; this allocation has been very attractive in the Life Sciences sector for some time.

     

  • PIPE Fund – Again, more commonplace in Life Sciences, a PIPE is a Private Investment in Public Equity, and this strategy is to invest in private placements for public companies, based on a manager’s unique view of the performance of a public company.

     

  • Overflow/New Ideas Fund – Allocations for projects deemed too risky or a bit off strategy for the core funds. These strategies are typically carve-outs of allocations in a core Venture fund, but the general idea is that a GP would charge lower economics on this type of fund to incentivize LPs to take risks alongside the GP. These funds are uncommon in the venture ecosystem, as GPs can already take considerable risk in their portfolios. 

Some Opps Funds are intentionally ambiguous as they are entirely in an ”other bucket” category where the GP is unsure about what types of investments are going into the vehicle, but they have enough flow that there will be allocations across the variety of strategies listed above. These are usually structured as SMA’s (Separately Managed Accounts), where a large LP is trying to put more capital to work than is appropriate for a Core Fund, but they want to increase their overall exposure to a GP. The most common combination of strategies that we see is a ~75/25 Select/Growth Fund, where a majority of the Opps allocation is for follow-ons in leading portfolio companies, and a bit of capital available for external growth deals that a GP has high conviction in.

Top Tier’s existing internal Opps Funds generally fall under the Scout and Concentration strategies. Our Scout activity is focused on emerging VC managers that could one day graduate into our core primary portfolio. We expect to take more risk, and with this, target higher absolute returns. Our other Opps Funds exist to fill excess allocation received on the platform across our primary, secondary, and direct investment strategies. Please reach out if you’d like to learn more.

Top Tier has evaluated a number of these funds, and what’s clear is some firms are just better at making money than others, regardless of the stage. While AUM growth and strategy drift can be concerning for LPs, including Top Tier, our preference is to back our long-time partners who have proven their ability to generate strong returns in the venture ecosystem. An interesting evolving dynamic that LPs are discussing, is that as many of the brand name early-stage managers are raising later stage Opps funds, an LP’s overall blended venture exposure is moving later in the capital stack, since they are typically expected to support these funds.