Are First-Time Winners-Only Funds The Best Way To Start Investing In The Indian VC Ecosystem?

The boardrooms of family offices, corporates, institutions, and fund-of-fund investors across the globe are abuzz with the massive wealth creation opportunity offered by the Indian Venture Capital (VC) ecosystem. These sophisticated investors are either allocating new lines of capital for India or doubling down on their existing allocations. These are promising signs for our ecosystem, which 3-5 years ago had a mere footnote participation in the global capital allocations for investors.

The surge of VC funds, especially micro VC funds, and the number of investments made have compelled Indian VC fund managers to innovate and create an attractive new investment vehicle. It goes by many names — an opportunities fund, a winner’s fund, or a follow-on fund. 

An opportunities fund is nothing new since most private equity fund houses have had such funds, and even VC fund managers have created side-cart vehicles for a specific investment. However, a dedicated fund to back winners is a new phenomenon and it has excellent merit. 

First, let me give you a primer on a few VC terminologies so we are on the same page.

VC Terminologies To Know

What Is A Micro VC Fund?

A micro-Venture Capital (‘mVC’) fund is a type of investment fund that focuses on making small investments in early-stage companies. mVC funds typically invest in companies in their seed or early growth stages. They may provide support in the form of capital, mentorship, and other resources to help these companies grow and develop. These funds often get managed by experienced VC investors looking to take a more hands-on approach to support the growth of early-stage companies. In India, the total assets under management (‘AUM’) of an mVC would be less than ₹500 Cr ($63 Mn) per fund.

Who Is An LP?

In a VC fund, a limited partner (‘LP’) provides capital to the fund in exchange for a share of the profits. LPs in a VC fund are typically institutional investors (such as pension funds, insurance companies, or other investment firms), single-family offices, and high net-worth individuals (‘HNIs’) looking to invest in high-risk, high-reward ventures.

What Is A Winners-Only/Follow-On/Opportunities Fund?

A follow-on fund is a type of investment fund created to invest in the same or similar assets as an existing fund. For example, VC firms and other investment managers often use follow-on funds to raise additional capital for their existing portfolio companies.

The First-Time Fund Manager’s Fund Opportunity

I became aware of the blockbuster investment opportunity of winners’ funds when the top management of a sought-after institutional investor quipped about their exceptional returns with winner’s-only funds of first-time fund managers.

I had heard about the already-established fact that first-time fund managers deliver significantly higher returns than their second or third funds. Still, the winner’s fund delivering exceptional returns was news to me, so I probed a bit more to understand. 

While several factors cause the compression of returns in the second or third funds, one critical aspect is responsible for the outsized returns of first-time fund managers. It is because first-time managers have more time and resources to devote to research and analysis, thereby improving their overall investment performance.

Therefore, it isn’t surprising that several LPs have specific allocations for funds started by first-time fund managers, based on a Prequin report of first-time funds outperforming non-first-time funds by over 30% in IRR terms on an average. The robust results are due to the high quality of assets, which is unusually outstanding for a first venture fund portfolio. These funds have a fat-tailed portfolio with several investments providing outlier returns (examples appended).

Therefore, when first-time fund managers need capital to back their top investments in follow-on rounds, it is evident that combining their top assets into a single portfolio would provide outsized results.

Besides, this investor added that not only do the first winner’s-only funds of first-time fund managers significantly outperform, but they also have a much lower risk because the target portfolio companies:

• are maturing businesses;
• get identified early, i.e., before they hit the market; and
• have founders with an existing relationship with the fund manager, providing them with asymmetrical access to information.

I left that call amazed that something so innately simple had such little research or data available online.

Winners Of First-Time Funds Of Marquee India-Focused VCs

So, my team and I put together the winners of the first-time funds of marquee India-focused VCs. We collected data from publicly available sources and identified investments where these first-time follow-on funds would have invested their capital, i.e., the Series B round.

The results (provided below) provide a blueprint of a follow-on portfolio that would have given fantastic results with much lower risk. The outsized results surprised us; did it surprise you?

 The data provides ample proof of the high-quality portfolio of first-time fund managers. So many of these startups have become a part of our daily lives and established themselves into solid businesses. Therefore, it should’ve been common sense that a fund backing the winners of these fund managers would create a blockbuster package with outsized returns.

However, it needed an apple falling onto the head of a brilliant scientist for him to come up with the law of gravity. I am not as bright or learned, nor is my discovery as ground-breaking for the world. But when it comes to venture capital and the opportunity to create outsized returns with much lower risks, backing a first-time fund managers’ winners fund is a realisation supported by solid data.