Traditional VCs turn to emerging managers for deal flow and, in some cases, new partners

It’s easy to understand the appeal of such firms, which manage enormous funds and wield tremendous power with founders. Still, as older firms look to recruit from a widening pool of new managers, they might have to wait on the most talented of the bunch; in some cases, they might be out of luck entirely.

There is, of course, a long list of reasons that so many people are deciding to raise funds these days, from the glut of capital looking to make its way into startups, to tools like Angelist’s Rolling Funds and revised regulations around crowdfunding in the U.S.

Emerging managers also seem adept at capitalizing on the venture industry’s blind spots. One is the excessive wealth of more veteran VCs. An investor’s experience counts for a lot, but there’s a lot to be said for up-and-comers who are still establishing their reputation, who aren’t sitting on more than a dozen boards, and whose future will be closely aligned with their founders.

Yet there are other trends the establishment has long overlooked for too long. Many firms probably regret not taking crypto more seriously sooner. Many male-heavy teams have also ignored for too long the soaring economic power of women, which new managers are driving home to their own investors.

Not last, many have stubbornly resisted racially diversifying their ranks, creating an opening for investors of color who are acutely aware of changing demographics. According to census projections, white Americans will represent a minority of the U.S. population within 20 years, meaning today’s racial minorities are becoming the primary engine of the country’s growth.

That new managers have shaken up the industry is arguably a good thing. The question some are beginning to wonder is whether they can maintain their independence, and that answer isn’t yet clear.

Like the startups they fund, many of these new managers are right now operating in the shadows of the firms that came before them. It’s a seemingly copacetic arrangement, too. Venture is an industry where collaboration between business competitors is inescapable after all, and it’s easy to stay on the good side of giant firms when you’re investing a non-threatening amount into nascent companies you’ll later introduce to the bigger players.

Ensuring that things remain harmonious — and that deal flow keeps coming — a growing number of venture firms now plays the role of limited partner, committing capital to new managers. Foundry Group was among the first to do this in an institutionalized way five years ago, setting aside 25% of a new fund to pour into smaller venture funds. But it’s happening routinely across the industry. Jake Paul’s new influencer-focused fund? Backed by Marc Andreessen and Chris Dixon of Andreessen Horowitz. Katie Stanton’s Moxxie Ventures? Backed by Bain Capital Ventures.

The running joke is that big firms have raised so much money they don’t know where to plug all of it, but they’re also safeguarding what they’ve built. That was the apparent thinking in 2015, when a then-beleaguered Kleiner Perkins tried to engage in merger talks with Social Capital, a buzzed-about venture firm founded by Chamath Palihapitiya. (The deal reportedly fell apart over who would ultimately run the show. Kleiner subsequent underwent a nearly complete management change to regain its footing, while numerous members of Social Capital left to start Tribe Capital.)

It’s also why we might see more venture firms begin to gauge the interest of new fund managers who they think could add value to their brand.

Likely, some will say yes for the sheen and economics of a big firm and because teaming up can be far easier than going it alone. Early-stage investor Semil Shah — who has built up his own firm while also working as a venture partner with different, established outfits (including, currently, Lightspeed Venture Partners) — thinks it’s “natural to assume that lots of new rolling funds” in particular will either “burn out, stay small, or try to scale and realize how hard it is, and perhaps go to a bigger firm once they have established a track record.”

If true, it’s not a scenario that’s as widely embraced as some might imagine. Eric Bahn, who cofounded the Bay Area-based seed-stage firm Hustle Fund in 2017, predicted last week on Twitter< that “establishment VC funds will acquire emerging VC funds, who are building differentiated networks/brands.” While in a different era, that might be seen as a cushy landing, Bahn added: “Not sure how I feel about this. 🤔”

He also later tweeted that “to be unequivocal, Hustle Fund is not for sale.”

For his part, Bahn says he’s “nervous about industry consolidation.” There have been “systemic issues with VCs being exclusionary in the past when it comes to women and other underrepresented groups.” He adds that even more recently he has “met LPs who — wink wink — really like men who come from Stanford and have computer science degrees,” leading him to fret that even a team with “good intentions can revert back to the mean.”

An industry friend of Bahn, Lolita Taub of The Community Fund — a $5 million early-stage fund that is focused on community-themed startups and backed by the Boston-based seed-stage venture firm Flybridge — is more sanguine about emerging managers’ ability to remain independent. Rather than gobble up smaller funds, she foresees more established players begin to fund — and nurture — emerging funds that have overlapping areas of interest.

Taub suggests that it’s the next step beyond VCs who’ve worked with so-called scouts to find undiscovered gems. “I think older players are looking to expand their reach beyond what they know.”

Both may be right. Either way, the industry is changing shape and some form of consolidation, though not imminent, seems inevitable once the checks inevitably stop flying. Some firms will break out, while others team up. Some managers will find themselves at top firms, while others close up shop.

Almost the only certainty right now is that a larger fund “buying” a smaller fund is “not that complicated,” according to fund administration expert Bob Raynard of Standish Management in San Francisco.

Asked about the mechanics of such tie-ups, he shares that it “generally involves changing or adding members at the GP entity level [leading to a] change in control of the funds.”

Maybe, too, he says, there is a rebranding.

The real challenge, suggests Raynard, is just “getting two VCs to agree on a value.” And that depends entirely on their other options.