To Investors,
“Capital flows to where it’s treated best.”
I’ve been pondering why the venture capital ecosystem in South Africa isn’t as vigorous as it is in other regions globally. We can talk about politics, demographics, and any of the many social issues; but I think that, although the space has grown significantly over the years, the South African venture capital ecosystem isn’t surging because fund managers aren’t using the right fund structures to effectively attract capital, allocate capital, and update the liquidity & risk profile of venture capital investing.
The current venture capital funding model was created in the 1960s and 70s. I can’t talk about what it was like in that period but I can promise you that it’s very different to today. The typical private equity/venture capital funding model includes a fund structure where you raise “X” amount with a fund duration of 7-10 years. As the fund manager you charge your clients an annual management fee for the duration of that fund, and then take a percentage of the profits in the event of a sale or “exit” from an investment when you return capital to your clients, when the fund matures. So as a fund manager you keep your clients locked in an investment for 10 years, with zero liquidity options whether the markets are booming or busting, and you charge them an annual fee no matter what, while you hope to make them a minimum 15-20% return on their investment. Seems like a hell of a lot of risk for the client for just 15% after 10 years.
While their capital is locked-up, South African investors must particularly worry about political uncertainty, demographic issues, and broader economic uncertainties such as whether this product can scale beyond South Africa’s small economy because it needs to scale beyond South Africa for it to be a viable product.
All of these issues are why experienced venture capital operators say that there isn’t enough risk capital flowing into the venture ecosystem. But maybe it's not flowing into the ecosystem because the liquidity profile needs to change (i.e. fund managers need to make investors more comfortable with taking risk).
I think that it's time for new fund structures across the board, no matter how “experienced” a fund manager you are.
Ninety One, Robert Hersov through African Gold Acquisition Corporation, Gabriel Theron through Cilo Cybin, Sequoia, Coatue Management, Pershing Square, and Social Capital, are a few examples of fund managers that have tried to encourage more of us to use these other fund models that may be better alternatives to the current general fund structure that I described earlier in this letter.
The alternative models I want to talk about today are Interval Funds, Evergreen Funds, and Special Purpose Acquisition Companies (SPACs). These are some of the fund structures that we’re exploring deeply, and I’ve been interested in these funding models for years as these are the special tools that the top capital allocators employ when they want to solve specific problems like liquidity constraints, long-term alignment, regulatory requirements, or even market psychology.
Let’s unpack these through real examples…
Interval Funds
An interval fund is a closed-end fund that does not trade on an exchange but allows redemptions at set intervals (usually quarterly), offering some liquidity while retaining the benefits of long-term investing.
Coatue Management, an ~ $60B tech-focused investment firm, recently launched an interval fund for their clients to allow the firm to manage public as well as private equity investments.
When talking about the reason for this new fund, founder of Coatue Management Philippe Laffont noted two problems that the firm is solving for. One is that they want to be able to create a new equities index that will replicate the success of the “Magnificent 7” stocks, however the basket forming that index must also be able to consider private companies like SpaceX or Stripe, as well as publicly listed companies.
The other problem that Coatue is solving for is the 10 year illiquid lock up that the typical venture model imposes on investors. At times when the markets are down, some fund managers may request an extension of 2 to 5 years because they wouldn’t be able to make a return for clients if they exited investments currently. So Philippe says that that is a difficult constraint because it puts the venture capital industry in a potential death spiral, and may stifle innovation because risk-averse investors = less capital available for new innovation. So Coatue’s interval fund allows a minimum investment of $50 000, and allows investors to withdraw 5% of the fund’s net asset value quarterly to give clients liquidity. However, this is subject to the fund’s overall liquidity and is not a guarantee that every investor can always redeem 5% of their individual investment each quarter if aggregate requests exceed the cap.
One great takeaway with this fund structure though, is that the minimum investment amount allows more participants and therefore draws on a larger pool of capital. The other great takeaway is that the little injections of liquidity to the investor (the people that give Coatue capital to allocate) make the investor more comfortable with taking risk by allocating to venture capital investing. These key features of Coatue’s fund structure give Coatue access to near-permanent capital.
Benefits for Coatue:
* Liquidity: 1) their clients have access to liquidity at intervals, and 2) allowing a minimum $50 000 investment spreads risk and draws from a larger available pool of capital. Both outcomes significantly make “illiquid” investments in private markets more attractive.
* Avoid Forced Selling: Unlike mutual funds, interval funds don’t need to be fully liquid daily. This prevents panic redemptions and allows managers to stay the course.
* This structure is particularly suited to more than just high-net-worth individuals, but also regular (but approved) investors who want access to venture-style returns but with more flexibility than a locked-up 10-year fund.
Evergreen Funds
An evergreen fund is a permanent capital vehicle, meaning there’s no end date to the fund. Profits are recycled, and capital is raised gradually. Think of it as a rolling investment firm rather than a fund with a fixed lifecycle.
Renowned investment firm Sequoia changed their entire U.S. model to an evergreen fund in 2021. The largest problem that Sequoia is solving for with an evergreen fund of this nature is that instead of investing in a startup at the seed stage, then getting the startup to an IPO and being forced to sell their stake to return capital to their clients; Sequoia gets to hold a position in a company from the private stage, into the IPO, and long into that company’s life as a publicly listed company. This matters because a lot of the returns that startups see is when they're actually publicly listed because they are more mature and have greater scale. A few examples of this are Tesla, Amazon, Uber, Apple, and SoFi, among many others.
In this evergreen model Sequoia allows their investors to decide if they want to hold their investment after a company goes public and not choose to call capital, or if they want to withdraw a portion and keep the rest invested in the fund. Alternatively the investor can also withdraw a portion of their capital annually.
Benefits:
* Longer-duration Capital: Sequoia aren’t forced to sell a position after an IPO, and can therefore benefit from upside realised after a company goes public.
* Attracts Additional Capital: the comfortable liquidity profile of an evergreen fund attracts more clients for Sequoia.
* Alignment with Founders: Sequoia sticks with founders for longer.
SPACs
A special purpose acquisition company (SPAC) is a shell company that is created to list a private company on an exchange, without going through the IPO process. How it works is that the shell company raises a bunch of capital, lists on a public exchange like the AltX, NYSE, etc., and acquires a private company.
With a SPAC funding model you are solving for the fact that there’s an important company that needs to be publicly listed to a) draw attention to the importance of that company, and b) attract capital from institutions like pension funds, wealth managers, and government support. The problem is that usually this company would struggle to successfully list through a standard IPO process because perhaps as an example the company is still years away from profitability – longer than most finance firms care to model. An example is when a South African company called Renergen listed through a SPAC in 2015 – a process managed by fund managers Trillian Capital and Integrated Capital Management.
I must reiterate that there are two large benefits to a business becoming publicly listed. One is that the business can start to put processes in place that make it easier to grow market access and attract additional capital from institutions and through government funding/contracts. This is because a publicly listed business must be more disciplined — reporting its audited financial statements periodically and on time, and must be transparent in all of its dealings, especially with regards to the regulatory environment relevant to that company. The transparency allows public scrutiny, which if the company passes, gives the company a clean bill of health to attract more customers and more capital. The other benefit is that all of that brings greater awareness to what the business is doing and gets the company closer to its goal – which should be to sell to every person in the world.
Social Capital also used this model in a number of examples, but one that stands out is when a rare earths mining company called MP Materials was taken public. The deal involved a SPAC called Fortress Value Acquisition Corp (FVAC) acquiring MP Materials through a deal that was estimated at $545 million. At the close of the deal, FVAC was renamed to MP Materials, and this process brought awareness to MP Materials and highlighted the importance of MP Materials in the global rare earth supply chain. With the recent tariff and trade issues raised in the United States, MP Materials is now positioned as a U.S. national champion in the global rare earth materials supply chain.
Additional benefits:
* Faster path to public markets
* Negotiated valuation instead of roadshow
* Allows firms to go public even when markets are shaky
Wrapping Up
In addition to encouraging more capital to enter the startup ecosystem by updating the liquidity & risk profile of venture capital investing, all of these structures also help founders by enabling capital allocators to give founders reassurance that fund managers (and the broader funding ecosystem) are truly with them on their journey.
In addition, these structures also allow investors to support a startup’s growth journey from early stages, to IPO, and maintain that investment long into that startup’s life as a public company.
These updates to the current general venture capital funding model make more sense if you remember that a lot of work goes into helping a startup to come into its own. The founders and their teams pour their lives into an idea and try to turn it into a successful business, so they need the broader capital ecosystem supporting them continuously. Capital allocators also put in a lot of tireless work to understand the intricacies of that business, help the founders recruit management and employees, and help them navigate regulatory environments. The bonds formed throughout this journey can seem like they also become abandoned at the end of an investor’s fund life. Maybe I’m wrong. But I think that these fund model updates may be imperative to injecting more energy in the venture capital ecosystem in South Africa.
If you're a fund manager, capital allocator, or represent an institution thinking seriously about the next generation of investment structures – and would be open to a deeper conversation – I’d welcome the opportunity to connect. We're currently exploring a few ideas in this space and would be glad to share more in a one-on-one discussion.
I hope you enjoyed reading this letter.
On my journey to becoming a master capital allocator, one lesson down, a billion more to go.
Hope you all have a great start to your week
-Mansa
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