There’s no denying that Zoom was an incredible venture-backed exit.
The video conferencing company, founded in 2011, raised some $145 million in funding from its backers, which included Emergence Capital and Sequoia Capital, among others.
Zoom then held an IPO in April 2019 and saw its stock surge about 72 percent on day one. The company was valued at $16 billion by the end of its first day of trading and ranked as one of that year’s most heralded IPOs.
And that was before the business skyrocketed a year later amid a pandemic that made it an indispensable tool for the enterprise and consumers alike.
Emergence, which led a $30 million Series C round in 2015, was Zoom’s largest backer and held a 12.5 percent pre-IPO stake, according to the prospectus.
However, the firm can’t help but feel like they left some chips on the table. That’s because the early-stage investor did not lead Zoom’s $115 million Series D round in January 2017, which valued the company at $1 billion, the revered unicorn level. Sequoia took that prize instead.
“We could’ve led the round if we had an opportunity fund,” says Emergence founder and general partner Gordon Ritter. “We would have liked to have put more money into them.”
As an early-stage investor, Ritter says it was like the firm was essentially “handing over the pro rata rights, as we were basically not taking advantage of a growing portfolio company.”
That’s what compelled him and his partners to raise its first opportunity fund in its 18-year history. In April, it closed on a $375 million vehicle called Emergence Capital Opportunity I, alongside the $575 million it raised for its sixth flagship fund.
Opportunity funds – sometimes referred to as growth funds or select funds – are nothing new. But they are undergoing a recent resurgence. By offering early-stage investors the opportunity to continue investing in their portfolio companies as they scale and raise large growth-stage rounds, firms are able to continue riding the rising tide of valuations.
Opportunity funds essentially offer early-stage investors the opportunity to benefit from rapidly growing portfolio companies. For example, if a portfolio company raises a later round and that comes with an attractive mark-up, then why not take advantage of a pro-rata allocation before the company exits and valuations skyrocket beyond reach?
A structure here to stay
Andrew Spellman, founder and managing partner of the Boston investment firm Fifth Down Capital, says opportunity funds are an attractive vehicle for all involved.
“They’re great for companies, giving the entrepreneurs equity from a known investor; they’re great for venture firms, helping them maintain pro rata rights, and they’re great for LPs, allowing them to stick with the fund managers they already know best,” he says.
“The opportunity fund allows us to stay committed to the companies performing
well without altering our early-stage strategy”
Gordon Ritter, Emergence Capital
The reasons for the various fund structures varies. Opportunity funds typically are built to pump more capital into the best-performing portfolio companies as they scale. Alternative funds could also offer existing LPs additional exposure to a growing attractive company. And they can help build a new relationship with an LP, who missed out on the flagship fund. Regardless of their purpose, they’re meant to complement a firm’s main early-stage vehicle.
However, the advisory service Different Funds late last year took a look at non-flagship funds – such as opportunity funds, special-purpose vehicles, syndicates and co-investment vehicles – and found they are a significant source of capital for many VC firms. And they’re growing in popularity.
Different Funds reported that in 2019, non-flagship funds (opportunity funds, SPVs, etc) raised $13.2 billion across 190 vehicles, which means they account for about one-fourth of total VC assets raised that year in the US.
These types of funds have also been outpacing the growth of the flagship market since 2010, resulting in their increasing share of the overall VC fund count. In 2010, non-flagship funds represented just 10 percent of total venture vehicles.
That figure stood well above a third by the end of the decade. The average non-flagship growth or opportunity fund raised upwards of nearly $70 million in 2019, Different Funds reported. And they have contributed just over half, or 54 percent, of all capital raised by the non-flagship market. This is due largely to their above-average size, as they account for just 19 percent of all vehicles raised over the same period.
A short history of opportunity funds
John Backus is believed to be one of the first to see the potential of an opportunity fund. At Draper Atlantic, which combined with DFJ New England to form New Atlantic Ventures in 2006, Backus launched a small opportunity fund in 2004 that invested in four companies and produced $2.5 billion in exits, “back when half a billion dollars was a lot of money,” Backus says.
“So, it was a great fund with a great J-curve and cash on cash return,” he adds. “And that was the beginning of opportunity funds. Since then, you’ve seen a lot of firms take advantage.”
Union Square Ventures then helped to pioneer what might be called the modern-day opportunity fund a decade ago.
USV blogged in January 2011 that it formed its first opportunity “to complement our core funds, not take us in a new direction.” Foundry Group, Homebrew, Upfront Ventures, Greycroft and Spark Capital, among others, soon after raised their own opportunity funds.
Since USV blogged about it a decade ago, observers say opportunity funds have picked up steam, fueled in part by frothy market conditions.
Peter Wagner, founding partner of early-stage investor Wing, says that the increasing trend of late-stage investors investing earlier and earlier in the funding rounds means the smaller, early-stage funds have to make a case for greater relevance. Thus, they raise opportunity funds as their portfolio matures.
“A lot of early-stage investors are raising opportunity funds, and that is part of their response to play a more substantial role, both in terms of their own ability to invest, but also to be relevant to the companies for a longer period,” Wagner says.
Backus now runs a firm called PROOF, which stands for PRO rata Opportunity Fund. The firm partners with other early-stage funds by providing capital when they exercise their pro rata for their portfolio companies.
“If the market was in a downward trend, you wouldn’t see as many opportunity funds,” Backus says. “But because so many companies are doing so well, it gives more people the ability to go to their LPs and say, ‘Look at our portfolio; we should double down in these companies.’”
Spellman of Fifth Down Capital says he has a number of venture managers in his firm’s portfolio looking at raising opportunity funds. “If you’re in a fund, and they have a handful of companies that are breaking out, why wouldn’t you want to double down and invest in their opportunity fund?” he asks.
A good alternative
The advantage of opportunity funds is that they limit the risk of a main, early-stage fund concentrating on a handful of deals. Firms and LPs don’t want to see a single company dominate a core fund in terms of capital at risk.
Emergence’s Ritter says about two-thirds of his firm’s opportunity fund will go into current portfolio companies. “We’re not going to invest in every one of our portfolio companies,” he says. “The investments from the opportunity fund is something we are going to have to be careful about.”
Some firms raising opportunity funds may look to bulk up a company’s team and hire staff, while others keep staff at the same size. Ritter notes that the new fund will be managed by the same group of partners as the early-stage fund.
Some investors say opportunity funds are easier to manage than an SPV, for example, which would have to be raise separately for each company’s later rounds.
“If the market was in a downward trend, you wouldn’t see as many opportunity funds.
But because so many companies are doing so well, it gives more people the ability to go to their LPs and say, ‘Look at our portfolio; we should double down in these companies’”
Likewise, Lindsay Searer, executive director of Colorado-based multifamily office Crestone Capital, says opportunity funds are an elegant solution to raising countless SPVs, which can be burdensome to administrate for early-stage firms with small teams. An opportunity fund provides an available pool of capital to invest from, rather than an SPV, which requires a fund manager to reach out to LPs when raising the vehicle. This is particularly important in today’s market with the high frequency of company fundraises.
“It is critical for GPs to be able to act quickly, and having a dedicated opportunity fund enables this, versus having to raise SPVs on short notice,” Searer says. “Each GP has its own reason for raising them, but I buy into it. Who better to identify the breakout companies in the portfolio than the early-stage investors behind them?”
She adds that about half of the multifamily office’s early-stage venture managers have raised an opportunity fund. As more firms raise opportunity funds, she says they present a chance for LPs to initiate a relationship with a high-quality, hard-to-access GP and “to expand the relationship to the flagship early-stage fund over time.”
Not everyone approves
Opportunity funds are not without some criticism. One growth-stage investor told Venture Capital Journal that he foresees a reckoning taking place when valuations soften and the economy slows. For now, though, valuation numbers are going up and to the right and opportunity fund closures are a regular occurrence.
“We’re at a bit of an unusual point in time, where we have a large number of companies raising up rounds quickly,” Backus says. “It’s easier to raise an opportunity fund because you have a lot more things you can point to in your portfolio that are doing well.”
Backus adds that if the current market was in more a downward trend, rather than spiraling up, there wouldn’t be as many opportunity funds. Data from CB Insights says there are more than 704 unicorn companies worldwide, as of mid-June, with a cumulative value of $2.28 trillion.
Opportunity funds roundup
Here’s a sampling of some the firms and opportunity funds that are either in registration or recently raised.
–8VC, which last year relocated from San Francisco to Austin, Texas, is looking to raise $880 million for 8VC Opportunities Fund II, according to a regulatory filing from mid-June.
–In mid-June, Westlake Village BioPartners filed a regulatory document that it raised $100 million from 25 investors for its first opportunity fund. The Los Angeles firm began raising it in December 2020.
–Princeton, New Jersey-based venture firm SOSV closed its inaugural select fund at a hard cap of $100 million in mid-June.
–Lux Capital raised its third opportunity fund in early June, at $800 million, alongside its seventh early-stage fund. Lux – an investor in Desktop Metal and Recursion Pharmaceuticals – expects about 80 percent of its opportunity fund to go into existing portfolio companies.
–Version One, an early backer in Coinbase, announced in early June its second opportunity fund, with C$25 million ($21 million) in commitments to invest in its most successful companies.
–LatAm-focused Kaszek Ventures raised a $475 million early-stage fund in June while also closing on $525 million for its second opportunity fund.
–Trucks Venture Capital, a transportation-focused investor in San Francisco, announced it raised more than $50 million for its early-stage core fund while also rolling out Trucks Growth to make later-stage investments in the best companies from its portfolio.
–In June, seed-stage investor Susa Ventures filed to raise $250 million for its second opportunity fund, alongside its fourth main fund.
–Montréal-based Diagram Ventures in June announced it raised C$60 million in the final close for its opportunity fund, bringing its total size to C$120 million, to back its most promising portfolio companies. The fund is anchored by Power Corp’s Sagard Holdings and supported by Canadian, US and European backers.
–In April, Emergence Capital raised a $375 million opportunity fund, its first in its 18-year history, alongside its sixth main fund.
–In May, Bain Capital Ventures raised $1.3 billion, combined, for its second opportunity fund and its main, early-stage fund.
–BITKRAFT Ventures, an early-stage investor focused on esports and gaming, is in registration to raise a $100 million opportunity fund. Regulatory documents from May indicate the fund is about halfway raised while it also seeks $200 million for its second main fund.
–Bessemer Venture Partners in February closed its second opportunity fund in addition to its latest early-stage vehicle.
–In fall 2020, True Ventures raised $840 million for its seventh core early-stage fund and its fourth Select Fund to invest in follow-on rounds in the firm’s rapidly growing portfolio companies.
–RRE Ventures in early 2019 raised about $58 million toward a $150 million targeted opportunity fund called RRE Leaders II, according to a regulatory filing at the time. No update was available.
A couple of LPs told VCJ they feel some pressure to invest in an opportunity fund strategy while they are committed to a firm’s main fund. And this is becoming hard to do as the pace of fundraising remains robust.
Laura Thompson, a partner at the LP-focused arm of Sapphire Ventures, notes that firms are raising bigger funds and are coming back faster than before.
Aside from committing to a firm’s successive funds, she says that fund managers have also been approaching LPs with multiple strategies, which can take up a larger share of the LP’s allocation.
This impacts her firm as it examines emerging managers.
“Sometimes there’ll be growth funds that are stapled to early-[stage] funds,” she says. “Those just take our dollars. If a firm is performing well, we’re going to first of all prioritize [those relationships] and then also re-up with those existing groups.”
While these instances provide LPs with opportunities to allocate more and more to some of their existing GPs, the competition among LPs to allocate large sums to the Sequoias of the world, where top-quartile returns are just as likely, is becoming more difficult.
Another LP likewise confirmed to VCJ that he and other institutional backers are focused on existing and veteran fund managers in the current environment, rather than looking at newly launched funds. He notes that as many established funds are looking for quick re-ups in the current environment, it doesn’t leave much room for anything new.
There’s a “slots challenge,” he says, for some LPs as they don’t have the bandwidth to add funds to its roster.
There’s so much noise in the market that it’s harder for new funds and fund strategies to stand out, he says. However, this could change soon as capital comes back to LPs when lockups expire from recent venture-backed exits.
Not every firm is seeking a separate opportunity fund. The strategy makes little sense for multistage leaders with billion-dollar funds, such as Battery Ventures, New Enterprise Associates and Norwest Venture Partners, among others. Those firms already invest from one main fund in everything from seed to growth deals.
Flagship Pioneering, an investor in coronavirus vaccine developer Moderna, is consolidating its venture and growth strategies under a single vehicle, according to documents from Massachusetts Pension Reserves Investment Management Board.
The firm had previously raised two funds in its Flagship Special Opportunities fund series, but instead of raising a third, it is rolling that strategy into its main fund’s mandate.
Meanwhile, London-based Felix Capital, which was an early backer of such high-flyers as Farfetch, Peloton and Deliveroo, raised a new $300 million early last year.
From the one fund, it will make early-stage bets and invest up to $15 million in growth opportunities, which it defines as its fast-growing portfolio companies and other growth-stage companies new to the firm.
Why not sooner?
A decade ago, the number of early-stage managers with opportunity funds was modest and their impact on the overall dynamics of growth-stage investing was small, especially when compared to the megafunds and hedge funds that are currently dominating venture rounds.
As one GP points out, most start-up entrepreneurs are more interested in the seed-to-Series A chasm and whether they can line up future investors for a Series A round than they are concerned with how their current backers can come up with the cash to maintain pro rata in their later stages.
But Ritter of Emergence says his founders and LPs like the idea of the firm’s first opportunity fund, and he expects they are here to stay. “The opportunity fund allows us to stay committed to the companies performing well without altering our early-stage strategy,” he says. “LPs don’t want us to lose our focus and we don’t want to scale beyond our craft as early-stage investors. And our LPs wondered why we hadn’t done this before.”