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US LPs are coming for UK VC funds

A new report looks into who invests in UK VC funds — and what impact Brexit has had on that LP mix.

By Amy Lewin

Member

If you think diversity in the VC ecosystem is not-so-great, wait till you meet the people who fund them.

Limited partners (LPs) are overwhelmingly men, finds a new report from Collective Equity — and that’s not the only problem with UK venture funding.

In comparison to the more mature venture ecosystem in the US, UK VCs are heavily dependent on government funding. They’re also becoming increasingly dependent on non-UK and non-European LPs, following the Brexit vote.

We take a closer peek at the data — the report looked at 42 VC funds in the UK and the 1020 LPs invested in them — and ask some VCs what all that might mean.

Who funds the VCs?

In the UK, 62% of LPs are high net-worth individuals or family offices. (Note, this doesn’t mean that high net-worth individuals and family offices put in 62% of the funding into UK VC firmsbut they account for 62% of the LPs listed at Companies House.) 17% of LPs are financial institutions, like investment banks, pension funds and fund-of-funds. 8% of LPs are corporates, investing via venture arms or subsidiaries.

Government organisations account for just 1% of LPs — but a chunky amount of the capital raised by VC funds.

In 2019, government money invested into European VCs topped $2.5bn for the first time — although the share of total VC funding coming from government is decreasing across the continent over time, according to the latest State of European Tech report. That’s a good sign, as is this: 2019 saw a big jump in funding from endowments and foundations and pension funds into European VC. Capital commitments from endowments and foundations jumped 2.2x from the average over the four previous years, while commitments from pension funds jumped 2.9x.

That is still vastly different from the US VC scene, where university endowments and pension funds plough in a lot more capital.

“It would be great if there was more reliable, regular LP capital available to VC funds in the UK. The challenge with family offices or high net-worth individuals is that they tend to dip in and out of investing in venture depending on the principal and their appetite and their interest in other asset classes,” says Check Warner, partner at Ada Ventures.

“The challenge with family offices or high net-worth individuals is that they tend to dip in and out of investing in venture.”

“University endowments, pension funds, fund of funds and governments tend to have a more consistent deployment strategy, more consistent and largely cheque sizes, and tend to be able to stay with the fund manager over multiple funds. This makes fundraising far more predictable.”

The British Business Bank is the biggest LP in the UK, in terms of both the amount of capital it has invested in VC firms and in the number of VC firms to which it has committed that capital. Its subsidiary, British Patient Capital, has committed over £1bn to UK VCs and has over 500 startups in its underlying portfolio.

“It is corporate welfare. Many of us are simply welfare recipients,” tweeted Hussein Kanji, managing partner at London-based VC firm Hoxton Ventures.

There’s a less well-known government LP too — the Nuclear Liabilities Fund. It’s a £15bn fund, set up “to meet the long-term cost of cleaning and decommissioning the UK’s more modern nuclear power stations”, with £250m of the fund managing by the BPC. It’s an LP in Passion Capital, Hoxton Ventures, Notion Capital and Connect Ventures, amongst others.

Why are so many LPs men?

Here, the report looks at the gender of the high net-worth individuals investing in UK VC firms.

90% of those 587 individuals are men.

That left 60 female LPs, none of whom invested in more than one fund — although 13% did reinvest in fund managers.

“I wish more high net-worth women knew about the huge benefits of investing in a fund — the information you get access to as a fund investor about deal flow, the access to ‘off market’ investment opportunities, co-investment opportunities,” says Warner. “It’s definitely a better place to start when you’d like to get your money exposed to early stage tech than trying to pick companies as an angel investor.”

“I wish more high net-worth women knew about the huge benefits of investing in a fund.”

You do, however, have to be pretty wealthy to become an LP. Many VC funds set a minimum cheque size of at least £100k, while the Financial Conduct Authority in the UK also has various rules around who can invest (including that they must have worked in the financial sector for at least one year).

Notably, some of the government and institutional LPs are more diverse. BPC is run by a woman (Judith Hartley), as is Horsley Bridge in London (Kathryn Mayne).

Do LPs back multiple funds?

Just 4% of the LPs looked at in Collective Equity’s survey backed more than one fund manager. Of those ‘active LPs’, just over a third (39%) are high net worth individuals and many of them are former startup founders.

“We don’t have LPs in Europe who are investing in VC funds repeatedly, rather than just on a one-off basis,” says Newton — and that’s bad for several reasons.

“Having a very low percentage of repeat purchasers means that the buyers are often poorly informed about ‘what good looks like’ and so they do not drive fund managers to be better — either when developing strategies, or once funds are closed and have begun investing,” he says. In the same way that experienced VCs bring value to their portfolio companies, experienced LPs can help VC firms get better.

“These ‘one off’ LPs also have little incentive to behave well themselves, for example in not ghosting managers or not reneging on verbal commitments. They are unlikely to invest in another fund, so it doesn’t matter if they alienate managers and develop a poor reputation in the ecosystem,” adds Newton. There is, as of yet, no ‘Glassdoor for LPs’.

Where do the LPs come from?

Most LPs in UK venture funds are, perhaps surprisingly, based in Europe. (Note, this data does not include high net-worth investors.) 51% of the family offices investing in UK VC firms are based in Europe (compared to 23% in the UK) and 43% of the corporates (compared to 25% in the UK).

However, Brexit is having an impact.

The proportion of European LPs investing in UK VC funds has dropped by more than 10% since the 2016 Brexit vote. The proportion of LPs from the rest of the world, meanwhile, has risen by almost 10%.

“An increase in US LPs investing in European VCs is great,” says Patrick Newton, founding partner at London-based Form Ventures, which launched in 2019. “In general, LPs coming from a more mature ecosystem like the US should improve the standard of European venture — by both identifying and backing the most interesting funds of the future, but also by setting a high bar of LP behaviour — coming as they do from a competitive market where they have to operate well to get into hot funds.”

“LPs coming from a more mature ecosystem like the US should improve the standard of European venture.”

“Unfortunately, our experience is that most US LPs are at a stage of maturity where they want a degree of exposure to the European market, but that usually means a top tier European existing VC — not the additional risk profile of emerging managers. The next stage in maturity, though, will be US LPs looking at emerging managers too.”

What needs to be done?

“We need the UK government to introduce regulation to push pension funds to invest a percentage of their assets into patient capital for the development of early stage technology,” says Warner. “We [also] need the LPs to transparently share their decision-making processes and report on diversity statistics in their portfolio of funds and the funds that they meet on an annual basis.”

This will make it easier for new fund managers to raise money, she thinks. “It’s a completely opaque black box at the moment which makes it virtually impossible for new and aspiring fund managers to navigate.”

“For emerging managers, there is no ‘go to’ list of LPs which could back their fund.”

Newton agrees. “For emerging managers, there is no ‘go to’ list of LPs which could back their fund,” he says. “This means that every manager has to build a fundraising list from scratch and labour through hundreds of pointless conversations. This makes fundraising timelines very long, and success is uncertain, which is a major barrier to new managers, especially those with limited personal financial means. In turn, this is bad for diversity at the VC level.”

Kanji from Hoxton Ventures also thinks any VC firm taking investment from a government LP should also have limits on how much its managing partners can pay themselves.

“People rail about poor people living off benefits but no one makes a big stink about corporate welfare recipients earning high incomes off of government aid,” he tweeted. “Personally I think if you take state aid, salaries should be capped to public servant wages and carried interest should be taxed as income. And all financial records should published and be part of the public domain. Good incentive to wean yourself off of the welfare.”

Amy Lewin is Sifted’s deputy editor. She covers VC and diversity in tech, and tweets from @amyrlewin. She’s coauthor of our weekly Startup Life newsletter, which you can subscribe to here.

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