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What is Rolling Funds: talking about a novelty in venture investing

Monday, December 6, 2021

Startup Jedi

We talk to startups and investors, you get the value.

Rolling funds or “tumble-fund” (the name offered by investor Nikolay Davydov) is a promising novelty of the venture investment market. How do revolving funds differ from traditional venture funds? What are their pros, cons and features, and most importantly: what are the future prospects? After all, now any high-profile phenomenon in the startup industry can easily turn out to be a short-term hype and at the same time, it may be a new stage in the evolution of the industry. What are we dealing with this time? We'll figure it out right now.

How does the Rolling Fund work?

The first time the world talked about revolving funds in February 2020, when Angel List announced the launch of its Rolling Fund, a fund that allows investors to quickly raise funds and invest them in a promising company.

If traditional venture capital funds are forced to collect investments to invest in a startup all at once, Rolling Funds offer to issue a kind of "investor's subscription".

How does it work? The investment amount which is determined by the manager, is debited once a quarter, just like in streaming services or apps. For the fund, it is more convenient because you no longer need to spend time constantly looking for new investments, since it becomes possible to quickly collect the necessary working capital within the fund and quickly invest them in new companies. For an investor, a revolving fund is good because it makes it possible to invest on a quarterly basis, regularly receive investment reports and adjust the subscription amount.

In addition, the structure of revolving funds allows them to bypass the restrictions of Section 506(c) of the US Securities Commission: in a traditional VC fund, the number of investors cannot exceed 29, which forces managers to look for investors with greater financial capacity. In Rolling Funds, there are no restrictions on the number of investors, so eventually, there can be more investors and funds. At the same time, another rule of Article 506(c) applies to Rolling Funds: all participants must be accredited investors with all the necessary documents.

The subscription price includes the fund's commission and the commission for administrative expenses. Each fund sets its own commission: for example, Angel Lists fund has 5% fund commission and 0.15% for administrative expenses.

Shares in Rolling Funds are also distributed quarterly: for example, you invested several thousand dollars only in the 3rd quarter, which means that you have nothing to do with investments in the 1st and 4th quarters. The funds that the fund manager doesn’t have time to invest during the quarter are automatically transferred to the next month. Another advantage of the new type of funds is that they can openly call to invest in them, in contrast to traditional VC-funds.

Are there any downsides? More like risks. 

Pavel Karasev, an expert at “RBK Investments”, explains that traditional venture funds usually cooperate with a partner for 10 years, and this is the optimal time for a startup to go through a full cycle of development. At Rolling Funds, the minimum term of cooperation is one year. During this time, the startup simply won’t have time to grow into a successful company, the investor may be left with nothing if he stops “renewing the subscription” and misses the fund's investments in a successful startup.

On the other hand, in such a high-risk venture capital industry, where a bad decision can lead to the loss of fortune, such risks are commonplace.

And how the usual venture fund works?

Among the many types of investment funds, startups are supported by venture capital funds, business angels and private investors. And if business angels and entities rather play the role of mentors, supporting a startup with small investments, then the venture capital fund is the one that provides investment "rounds", investing in the company amounts that are enough to move to a new level.

In order to understand the difference between VC-funds and Rolling Funds, let’s remember how traditional venture funds operate.

  • The average lifespan of a fund is 8-10 years (and it is a standard life cycle of a successful startup: from Seed stage to entering IPO/being bought by a corporation).

  • Manager of a fund is a General Partner, and investors are Limited Partners; in the USA, according to the legislation, there can be no more than 29 partners.

  • The fund actively raises funds from investors and invests them in the company for the first 3-4 years, and in the next few years it expects to receive a profit after entering the IPO or the sale of the company.

  • After this, a fund returns investors the funds plus dividends, retaining a carry, which is usually 20% of the revenue and up to 2% commission for the fund’s work. 

What are the major advantages of Rolling Funds?
  • The subscription format allows Rolling Funds to continually raise money, receiving funds from investors every quarter.

  • A revolving fund can act on the open market and openly encourage investors to invest in it.

  • There are no limitations on the number of investors.

  • The venture investment entry barrier is being reduced: now not only billionaires with huge fortunes can try themselves in investments, but also, “star” employees of the largest corporations, serial entrepreneurs and startup founders.

  • More investors and more “subscriptions” automatically means more opportunities for startup founders, which will give a new impetus to the development of the entire industry.

  • The time to get return from startups decreases due to constant quarterly investment in startups.

How will Rolling Funds influence the venture capital industry?

Currently, tumble-funds are heading straight towards capturing the venture capital business. It wasn’t a coincidence that we mentioned Nikolai Davydov at the beginning of the article: together with his wife Marina, they just launched the Davidovs VC fund in the Rolling Funds format. The fund plans to make 4-6 deals per quarter and the minimum subscription amount is $30 000. Davidovs VC will focus on investmenting in startups that use artificial intelligence (AI). According to Forbes, Viktor Orlovsky, the investor and founder of Fort Ross Ventures, investors Daniil and David Lieberman, ex-director of Snapchat and many other businessmen from Silicon Valley have already signed up.

One of the "tumble-funds" (Footprint Coalition Ventures) belongs to actor Robert Downey Jr., the Austen Access Fund was created by the founder of Lambda School. You can find a list of existing Rolling Funds on the Angel List platform. Since February 2020, there have been created about 70 such funds around the world. Investors from China, UAE, India and Canada received the most subscriptions. And this is only the beginning!

Avlok Koli, the CEO of Angel List (remember,this is the company that came up with a new format of funds) describes Rolling Funds as "this is what a venture infrastructure would be if it was built according to the principles of software development." First Found founder Josh Kopelman, the founder of First Found, sees the Rolling Funds model as creative and promising.

In the nearest future, we will see whether new types of circulating funds will continue to appear actively, but it is already clear that such a format can greatly change the entire venture capital industry. So how?

  • Increasing the number of venture capitalists: this is facilitated by a lower entry threshold, no investor limit and a subscription format.

  • Growth of investments in promising startups at an early stage.

  • Increased competition among investors for promising startups: and eventually, the growth of the investment market and a new impetus for the development of the entire startup industry.

Briefly about Rolling Funds activities

Management. All administrative and legislative work lies with the fund manager: preparation and verification of all legal and regulatory documents, registration of bank accounts, submission of tax reports, marketing development of the fund, managing participants’ "subscriptions" and reporting to them, and much more. Actually, that’s why the fund receives its "administrative" interest.

Structure. The Rolling Fund News team explains that the revolving fund is structured as a series of limited partnerships: at the end of each quarter, a new fund is offered on almost the same terms. This system allows the fund to be public and open to new investors.

Deposit amount. The minimum and maximum size of the "subscription" is determined by the fund manager: currently, the entry bar for Rolling Funds is lower in the American market: it ranges from $2500 to $50 000.

Commissions. Each fund has an administrative fee; for example, in AngelList it is 0.15% for all working capital. Many funds also introduce a fund management fee, which ranges from 0.5% to 3%. Finally, the carry is usually 20% of the revenue.

Summing up: why do we need Rolling Funds?

Rolling Funds is a logical step in the "evolution" of venture capital funds, which makes this market more accessible to new investors. Transfering the subscription mechanism to the venture capital industry turned out to be a successful format due to its simplicity, convenience, and the ability to circumvent some of the legal restrictions of venture funds. 70 “tumble-funds” in less than a year and a half is a serious figure. As well as, the interest of successful investors from Silicon Valley to create their own similar funds.

In the long term, the Rolling Funds model is able to attract hundreds of new venture capitalists, which means that it can increase funding for the startup industry and accelerate the emergence of new disruptive technologies.

It’s really interesting, how usual VC funds will react to the emergence of such an unexpected competitor? And how are they going to interact (and maybe change) given the situation? It will be interesting to see this pretty soon!

6 Dec 2021

 

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