Will Rolling Funds Roll Over the Venture Capital Industry? Long-Form
Rule 506(b)
Let’s start with how rolling funds legally work. For context, most venture capital firms fall under Rule 506(b) of Regulation D under Section 4(a)(2) of the Securities Act of 1933. Regulation D is a set of rules that offers exemptions from the registration requirements of the Securities Act. Put simply, being a registered entity with the SEC is a pain from both a financial and human capital standpoint. Regulation D allows VC firms to avoid becoming registered entities if they meet certain criteria. Most VC funds up until this point used Rule 506(b). Under Rule 506(b), an issuer may offer and sell an unlimited amount of securities so long as the issuer does not engage in general solicitation or general advertising, only accredited investors are investors.
Rule 506(c)
AngelList has created a viable fund structure under Rule 506(c) of Regulation D, which is pretty similar to 506(b) except that offers may be made to investors via general solicitation or general advertising. All investors must be accredited investors and the issuer must take certain additional steps not required under 506(b) to ensure that the investors are accredited. Sounds simple, but there is meaningful infrastructure needed to support the additional accreditation measures imposed by 506(c). Added disclosure requirements for limited partners and friction in the process has created roadblocks to broader use of this exemption.
The allowance of general solicitation under Rule 506(c) is relatively new. It was introduced as part of the JOBS Act of 2012. The JOBS Act is one of the most important pieces of business legislation of our time, paving the way for crowdfunding and the continued potential for the democratization of financial services.
AngelList Rolling Venture Fund
This is where AngelList steps in. They handle the on-boarding of accredited investors so that the VC firm doesn’t have to. Suddenly, the roadblock to general solicitation is removed.
The other part of what AngelList is doing, namely, the rolling fund structure, is entirely distinguishable from the Rule 506(c) general solicitation concept. It’s essentially a set of separate, consecutively offered, investment vehicles, organized under one master entity. You can set the minimum investor commitment at 1 quarter, 4 quarters, 8 quarters, 12 quarters, etc. This allows for flexibility in making it look more like a traditional fund (e.g. a 20-quarter investment period) or a more typical rolling fund (4 or 8 quarter investment period). It is entirely up to the fund to set the terms. Many liken rolling funds to a SaaS/enterprise software model since investment commitments auto-renew and stay “on” until and unless an investor turns it “off.”
Management fees and carry do not change with the rolling fund structure. You can continue to charge the same management fees and carry that you otherwise would in a traditional fund structure. You can also limit the fund size. The main distinction from a “traditional” fund is that new investors can come in at any time during the investment period for the next quarter’s fund. Whereas in a traditional fund, you raise, you close, and then no new investors may join. Limited partners will need to be educated about the rolling fund model. They will need to understand that if you skip investing in certain quarters, or join later after the start of the fund, the companies invested in during your “off” times will not be in your portfolio of investments. Carry is calculated on only those companies that are in your particular basket of investments.
But the rolling fund structure may appeal to many. Fund managers historically had to raise their entire fund’s capital in a limited amount of time, typically 6 to 18 months. It is an arduous and time-consuming process. During the lengthy fundraising process, VCs may lose out on great deals that they are unable to close because they are often required by investors to aggregate everyone, or at least a majority of limited partners, into a single close. The rolling fund structure allows VCs to start investing while still fundraising. In fact, you’re always fundraising because the fund is always open to new investments.
In addition, the SEC imposes various restrictions on the number of limited partners in a venture fund. The rolling fund offering at AngelList supports various parallel vehicles that allow for flexibility for these funds to raise from a larger pool of limited partners than they otherwise might have been able to. One can only hope, but if some of these limits are either eliminated by the SEC in the future or AngelList and other platforms are able to get an exemption from the SEC, it will lead to a flood of additional funding options for VCs.
One of the most critical parts of AngelList’s offering is the back-office services for the rolling fund, including tax, accounting, and fund administration (e.g. capital call notices, capital account statements). Quick, simple onboarding and ample staff are available to answer questions. You can see and track commitments that roll in on the interface in real-time. Of course, AngelList charges a fee for this service, but according to them, they expect the fee to be the same or lower in a rolling fund versus a traditional fund structure. So far, I have heard positive reviews of AngelList’s onboarding process from friends who recently set up their rolling funds.
Now that AngelList has turned venture capital into an end-to-end software, I suspect there will be future opportunities to toggle existing features and we will see the introduction of new features.
Implications for the Venture Capital Landscape
What does AngelList’s new rolling fund program mean for the venture capital landscape?
1. The explosion of micro-VC funds. Through general solicitation, we may unlock more money for investment into venture capital. VCs may be able to tap into entirely new pools of capital not yet exposed to venture capital. As a result, may see the explosive growth of micro-VC funds. The AngelList platform is ideal for the micro-VC seeking to raise primarily through individuals as investors. They are able to raise a fraction of what they would otherwise need to raise via a traditional fund and can start deploying the capital immediately.
2. Increased competition for Series A dollars. If there is a proliferation of micro-VC funds into the early-stage market, we will see many more start-ups get funded. We may also see an increase in micro-funding rounds of $50,000 to $250,000. A glut of seed-backed startups will intensify competition for Series A funding unless the total venture capital money dedicated to Series A proportionately increases. It’s possible that with an increased number of micro-funds in the market, we may see an increase in the funding of companies needing less capital over their life cycles and that have smaller exit potential. Smaller exits are far more realistic and if done at scale, may have potential for a broader base of wealth creation. From a VC vantagepoint, successful exits are measured by multiple of return. So it’s possible to still get outsized returns this way.
3. The rise of the Branded VCs. Individuals with large social media followings may be able to leverage their platforms to fundraise from an already engaged audience. Sahil Lavingia, CEO of Gumroad, fundraised primarily by marketing his fund on Twitter to his more than 124,000 followers. Similarly, creators with large subscription newsletter followings, also already engaging their audiences, may be new entrants into VC. Their investments could be synergistic with their content and expertise. For instance, a YouTube influencer may raise venture capital on his YouTube channel to invest in other YouTube creators. Welcome to the world of Twitter VCs, YouTube VCs, Instagram VCs, and more.
4. The rise of Niche or Specialized VCs. We may continue to see an increase in funds being created by specialists in product marketing, DTC branding and distribution, crypto, AI, machine learning, design, and more. We’ve already seen this trend begin. For instance, Bobby Goodlatte and Josh Williams’s new fund, Form Capital, will offer design services to founders. We may also see more Seed funds with narrow investment focuses or themes. Several Niche VCs launched their rolling funds on AngelList, such as Jason Jacob’s fund focused on climate change, Inyinoluwa Aboyeji’s fund to invest in Africa, and Stephen Hays’ mental health fund. If this happens, founders will be able to custom create pre-Seed and Seed financing syndicates comprised of a combination of VCs that best fit their company’s needs. It will further shift power to founders, where they are the buyers and the investors are the sellers. A more competitive early-stage VC market in which founders can cherry-pick their investor dream team leads to better and more differentiated investment theses as well as higher quality value add by VCs.
5. The era of Operator VCs. Because of the ease of the AngelList platform, Operator VCs will continue to run their companies while in parallel running their rolling funds. For example, Sahil Lavingia, will continue to run his company Gumroad alongside his rolling fund. Side hustles will become main hustles. As part of the gig economy and creator economy movements, we will be able to have multiple jobs and sources of income, including a start-up, a VC firm, a paid subscription newsletter, a podcast, etc.
6. The further decentralization and fragmentation of venture capital. Further on, we may see larger funds, especially those run by solo capitalists with a limited team and back-office support, turn to the rolling fund platform for their fundraising and fund management processes. VCs will be able to leverage portfolio markups to be able to raise new capital on an ongoing basis. VCs can gradually grow their fund size without needing to follow a traditional fundraising process. We may see reduced reliance of VC firms as the traditional career path for associates to make partner. VC associates with a strong personal brand, social media presence, and support of prior portfolio companies willing to vouch for them can start their own rolling funds. VC associates may thereby be able to accelerate their career paths. We may also see a rise in rolling funds due to the spread of the Solo-X model (Solo Capitalists, Solopreneurs, Solojournalists), which is in part being propelled by the shift towards remote work.
7. The downstream push of institutional VC firms. We have already seen the proliferation of super angels and micro-funds in the past decade. The growth of their market share in the venture capital industry may be further catalyzed by the emergence of rolling funds. As the pre-seed and seed markets get oversaturated with micro-funds, institutional VC firms may move towards progressively later-stage investments, where their infrastructure and deep pockets will continue to remain valuable. However, we may find at the pre-seed and seed stages that more and more founders will choose to work with individuals over firms.
8. Rolling funds as the new parallel funds. We may see some VC firms raise capital via a hybrid model of rolling fund and traditional fund. For instance, a Series A fund may raise a Series Seed rolling fund that will act as a source of deal flow for the main fund. There are many options for blended or hybrid models of traditional funds and rolling funds, thereby also accommodating simultaneous public and private fundraising.
9. The shift towards remote fundraising and the reduced reliance on traditional limited partners, as well as the creation of a GP marketplace. Venture capital is now an end-to-end software product. This may lead to the creation of an online marketplace of VC firms. There may be an increase in remote fundraising as well. VCs will rely more heavily on Notion, PowerPoint, and Zoom to communicate with prospective and current limited partners.Limited partners will be able to view profiles of different VC firms and select which to invest in from the marketplace of VC firms. This may lead to reduced reliance on personal connections to traditional VCs. Forward-thinking limited partners can make small investments in multiple early-stage rolling funds, and then double-down on those that break out from the pack in subsequent quarters.
10.The globalization of venture capital, but also the proliferation of unsophisticated LPs. Due to the rise of remote fundraising, VCs can have limited partners from all over the world, many of whom they have never met. It also means that there may be a competitive marketplace for the best VCs the world over. We may also see the rise of venture firms based in Africa and Latin America who will now be able to market and raise their funds, possibly from backers of traditional Silicon Valley fund investors, coinciding with the increased flow of venture capital dollars into these geographies that is already occurring. However, there are risks in taking on limited partners that you don’t know or that are not sophisticated in buying venture capital as a product. Risks may involve unfounded complaints and misalignment, misinformation, or misunderstandings around fund objectives and performance. GPs may need to engage in heavy hand-holding of unsophisticated limited partners in answering even the simplest of questions. VC firms will need to implement policies around who and where they will accept money from in order to mitigate these risks. Perhaps AngelList and others can offer simple online education programs to first-time limited partners to further mitigate these risks.
11. The introduction of advertising as a business unit in VC firms. Rolling funds are able to advertise their funds during the fundraising process. We may see increased advertising by venture capital firms on social media platforms, via newsletters, e-mail blasts, conferences, and in niche communities (crypto/token communities and others). This may introduce the concept of advertising budgets for VC firms. VC firms may start to more closely resemble traditional businesses that will have departments dedicated to marketing, advertising, etc.
12. The introduction of less sophisticated VC entrants into the market. As we enter an era of untrained VCs starting to make investments, we may see a lot of rookie mistakes occur. VCs who have not been trained in corporate governance, fiduciary duty, and the legal, tax, and accounting implications of running a fund may encounter a host of challenges. Hopefully, this will coincide with the rise of venture capital education products in the market as well, both for general partners and limited partners. AngelList and other platforms may be able to helps new VCs avoid common pitfalls.
13. Copycats galore. Don’t be surprised to see online fund administrator platforms like Carta, Assure, and others create their own version of 506(c) funds and rolling funds in the future. It’s a matter of time before AngelList has competitors.
Implications on Diversity in Venture Capital
Rolling funds have the potential to positively impact the diversity landscape in venture capital. Women and people of color can potentially raise investor money by leveraging personal brands, followings, and communities they have created. They don’t need to know how to play the fundraising “game” involved in raising money from traditional limited partners. There may also be less emphasis on empty pattern recognition indicators, such as a degree from an Ivy League college. I can envision someone like Naj Austin from Ethel’s Club, with a strong cult following and powerful community, creating a venture fund that will be a “product feature” – one of several offerings in addition to the company’s workspaces, online marketplace, concert space, etc. General solicitation also allows for amplification opportunities on social media for women and people of color. Previously, all fundraising has been behind closed doors and entirely a black box process. The rolling fund platform has opened the doors to the potentially broad discoverability of diverse GPs for the first time. In short, rolling funds may open the door for more money in many different hands.
However, the introduction of the rolling fund platform may also make it easier for more non-diverse VCs to raise their funds than are already able. If AngelList wants to help level the playing field, they can implement measures like waiving their administrative fees for underestimated VCs. That is just one small example, but I’m sure there are many other possibilities.