Starting a VC Fund, Episode 13: LP Communications & Reporting

Hi there. I'm Patrick Iwas. I'm the founder and CEO of MindMaven, an executive coaching firm that helps people achieve true greatness by focusing on relationships. And here we have.

I'm Charles Hudson, managing partner of Precursor Ventures. We invest in founders at the earliest stage possible.

And today I'm really excited because I'm going to talk about something very, very central. It's about LP Communications and the reporting. And the first questions I have for you Choose, Charles, is of course, why is it important? Why do we have to do this?

Well, I think LP Communications is something a lot of managers overlook. You get so focused on closing your fund and making investments, it sounds crazy, but you can forget about the need to keep others in the loop about what you're doing. And so I think there's sort of the practical reason why LP Communications is important. It's the way that you keep your limited partners and your key stakeholders in touch and in tune with your strategy and progress. But there's also this really basic thing which is most limited partner agreements or the documents that govern how your fund runs require you to provide certain documentation to your limited partners on a regular basis, whether you get value from communicating with them or not.

Okay.

I gotta ask you this question. So, you know, I bet a bunch of people, especially first time fun, and I just make a bunch of mistakes. So what are the mistakes that maybe I wouldn't be thinking of? And if you can be so kind, what are the mistakes you've made?

Oh boy. Well, I'm still on my journey of really learning how to communicate with our limited partners. I'd like to think we're better today than we were when we started. I think one of the real challenges is tuning what level of detail you want to share with your LPs. And I think there's this beautiful match that happens when the amount of data that you want to share with your limited partners is the same amount of information that they want to consume. For example, I have a friend who shares every single investment memo that his firm writes for every investment with all of his limited partners. And, you know, I think he probably has a couple of LPs who love getting that level of minutiae and detail about every investment. But remember, your LPs are busy too. They, you're probably one of several funds that they're in. They want to know what you're doing. But in the same way that you don't want to know the outcome of every A B test that your portfolio companies run, your investors need the Right. Level of resolution around what your fund strategy is. And so what I tell people is you can Certainly give your LPs too much, too much minutiae, get them too far in the weeds, bombard them with so much email and content that they can't parse through it all. You can also give them too little where they don't really have any insight into what your strategy is, how things are evolving, how things are going, and they just don't hear from you about how you feel about the portfolio. So I think getting that balance right is hard. One, because different types of LPs have different sort of interest levels. And two, it's a skill that you probably haven't practiced before.

Okay.

So after this, like, like, like what are the nuts and bolts of, of actually LP communications?

I think there's a handful of things that I would break down into what we'll call sort of the voluntary piece. And I would say the required piece. Let's maybe start with the voluntary piece, if that's all right. Yeah, so one of the most surprising things that happened to me when I was starting, you know, our first fund was $15 million, pretty small fund. I had about 50 some odd LPs. One of my LPs pulled me aside one day and said, you should really have an annual meeting. I said, annual meeting for my little 15 million dollar fund. I don't want to impose on our LPs, I don't want to create more work and burden for them. I don't know what I would say. And he said, look, your AGM annual general meeting, it's not just for you, it's for your LPs. It's a chance for them to hear directly from you about the strategy and performance over the last year. It's a time for you to build relationships with them. It's a time for them to connect with each other. As he told me, it's a time for them to talk about you to your face in kind of casual one on one meetings. And I was really skeptical about the value of doing an annual general meeting for a small fund. And now I am a complete and total convert. It's probably one of the most important things we do every year is invite all of our limited partners to hear what we've been up to, but also ask us questions about our strategy and approach.

And they come even if you have a super small fund.

We've done them in person and on zoom in the pandemic. And I have to say attendance has been far greater than I had Expected. The amount of input, interaction we've gotten from LPs in the meeting has greatly exceeded my original expectations. And the number of follow up conversations the AGM has spawned with people who are interested in investing in the next fund or have a question about some data point that we mentioned. It really is a good engagement mechanism and it's worth the time and effort put into it to put everyone together.

So hands down, you're saying like, no matter how big your fund is, start planning for doing an annual meeting even in your first year?

I really think so. Unless you have some tiny LP base. So if you have, you know, four or five LPs and it's, it's a really small manageable group, maybe it's not worth it. My hunch is most people listening to this video will not be in that bucket.

Yeah, exactly. So I would be like, shit, this is another piece of extra work that I actually didn't think I had to do. Why is it worth it? You know, like what? So sure it's part of what you should be doing to take care of the LPs, but like, you know, there's more that you will probably also get out of this.

I think there's a certain amount of trust building and relationship building that happens in the process of convincing an LP to invest in your fund. But then you have this sort of relationship development, deepening thing that happens once they're in the fund. You're going to work with these people for 10 years. And I found our AGM is a really good way to build trust and confidence among our LP base, to take the time to sort of walk them through the things that we do every day that might seem really obvious to us, but they're again, they're not in the weeds, they're not in the firm every day. And in the same way you as a VC will go to a board meeting and hear six months, six weeks worth of work, or a quarter's worth of work distilled down into two hours and get a lot of value out of it. Your LPs can hear a year's worth of work distilled into a half day presentation and come away feeling much more connected to you and the work.

Ah, love that. So I have a question that I have to ask just for, because of what I do. Do they also love coming because they meet other LPs and.

Absolutely they do. And sometimes it turns out that they're invested in other funds together. It's a chance for them to connect with each other and catch up it's also a chance for them to spend time with team and other members of the firm who maybe they don't get as much exposure to. So we bring our whole team to the agm and usually we. One thing we do is we do a reception after the AGM where we invite our portfolio company founders to come hang out. And it gives our LPs a chance to talk to our portfolio companies unsupervised and ask them, what's it like? What do you do? And I feel like that reception for us is a good way for RLP is to make, you know, what would otherwise be a bunch of companies on a spreadsheet feel much more human and tactile.

Yes. And I think what a lot of people underestimate that LPs want to feel like in touch with the market, even though they're not directly investing. And so you are offering a vehicle for them to have that experience.

Right, Right.

Okay, cool. So what are some other things you can do to get these LPs closer to you?

So we do a quarterly letter for every fund. And I would encourage people to do that. Now. We. We took the position that or I took the position, rather. I was going to do a separate quarterly letter for each of our funds because each of our funds is in a different place in its life cycle. And the issues for our first fund, the things to talk about are very different from our most recent fund. Our most recent fund is still very much in the selection and deployment and dealing with the current market. Whereas our first fund's kind of in harvest mode. And like those bets have all been placed and those dollars have been deployed.

Okay.

And I. Yeah. And I find the process for me of writing the quarterly letter is a great way for me to organize my own thoughts and to reflect on what happened in the quarter. It's a nice little time capsule to go back and read what was I thinking Q1 two or three years ago, early on the fund. And you know, I write it as much for myself as I do for LPs.

That's awesome to hear. I heard about something interesting called LP Advisory Councils. Tell me about those.

Yeah. I think the other thing sometimes people ask me is, should we have an LP Advisory Council or advisory committee? Lpac.

We have an ELPAC for each fund at precursor. And I have to take. Tell you it's been extremely valuable for me as the gp. So for most funds, what you end up doing is you create an LP Advisory committee, which is usually your three or four largest limited partners, usually by dollars committed to your fund and you know, you commit to keeping them in the loop with some frequency. We do three quarterly LP meetings plus an annual meeting once a year. And I think it's super valuable because three times a year I get to talk to the largest LPs in each of our fund for an hour or two about the top of mind issues I have, give them an update on performance, get their feedback and input on our performance and really have a dialogue with them about what's happening in the fund. And I've really gotten to know them a lot better through the lpac. And also it means that my largest investors are going to hear from me minimum four times a year about what's happening at Precursor. And if you're trying to cultivate long term relationships with support of LPs, I think this is a great way to build those relationships.

And I don't think we have to explain to anybody here watching us why that's a good idea. Right? So that's good. So what about.

Figuring out what your LPs want in terms of communication? Is that you determine that or is there a certain balance you have to strike?

I think there's some amount of trial and error. So we've certainly produced materials for our LPs where a few of them have called me and said, hey, that was kind of a lot to digest. I really appreciate the time and energy you put into that, but that was a lot at the flip side is I have individual LPs, family offices or high net worth individuals who want to talk all the time about individual deals or they'll say, hey, I'm looking at making a personal investment in this company. Have you seen it? Have you seen anything else in the space like it? What do you know about X, Y and Z Fund? I'm thinking about becoming an lp. And part of it is I think your job as the, as a general partner is to learn who needs what. I have some LPs who are like, just give me my quarterly letter, give me my quarterly financials on time, get tax and K1 done and I'm good. I have others who are like, I'll read everything you've got. You send it, I'll read it. No much, no, no amount is too much. And I think it just takes time to sort of calibrate what people want. And so what we try to do as a firm is make sure that we produce enough written and in person content for LPs that people with reasonable expectations should be satisfied and people who express an interest in more we will produce custom stuff for them or we will share more with them, but only if they express a desire to hear it or see it.

Let me sum this up. What I heard you say is basically find sort of a balance that is sort of like enough for most and then basically for those that want more, you take ad hoc opportunities to reel them in and show them that you're thinking about them. Is that pretty much just okay? That's awesome to hear. All right, good. You started off saying there's voluntary things and then there are required things. Let's. Let's talk a bit more about the required communications.

Yeah, I think if you could only nail one side of the coin, nail the required communications side, that's the really important piece because nothing will diminish you in the eyes of your limited partners in terms of your ability to run a fund like being late on required reporting. And you know, sometimes it's beyond your control, sometimes you have circumstances that you know you can't handle. But part of your job as the GP is to get that stuff done on time. And so for most funds it's, you've got, you know, your K1 statements for tax. And so you don't want to be the one fund that's holding up all of your limited partners ability to file their own taxes. So you get the K1s done. Normally you've got some annual tax and audit process you have to go through that's a precursor, no pun intended, to producing those K1s for your LPs. And it's really important that you stay on top of that stuff in your limited partner agreement. Or your LPA will usually specify what you have to do. For example, where we're required to produce quarterly financials within 45 days of quarter. Close.

Okay. Annuals on a certain schedule as well.

So give me an example of how it is really easy to basically.

Screw.

Up a important LP relationship with something that actually feels extremely unimportant to the work you have to do to be a successful vc.

So one easy way to screw things up is, you know, we invest primarily in U. S based companies in precursor, but we have a few companies that are non US and have foreign tax years and reporting requirements that are not in sync with the US tax calendar. So we've had situations before where companies in our portfolio simply haven't completed their fiscal year end and cannot produce the documentation we require to be able to meet our reporting deadlines. So we've had our whole closing process at times held up by one or two companies and their foreign reporting requirements and just the delay between us needing it on a certain date and then not needing to file in their home country by another date. And you know, honestly I don't blame them. Most LPs, like, I don't care why this is late, fix it, get it to me on time as you sort of signed up for. And so it's really important to get ahead of those things if you know that you've got those issues lurking in your portfolio.

Yeah, but, but, but why, you know, so what the LP is, you know, how's LB bothered by that? So you're a little late. Who cares? I'm asking a little bit in the E3. Yeah.

I think it's worth remembering your limited partners, they have reporting requirements of their own. They've got taxes to file, they've got year end reports to submit to their institution or their client or whoever it might be. You know, they're, they're in business too. And part of what they're counting on is they're counting on you to make their life easy and help them run their business on schedule. And when you're late, they're probably late for somebody else.

And that can be very, very uncomfortable because it's just a non important like not, not, not mission critical thing that can really impact that relationship because it can get quite, quite upset about those things. Right.

Yeah, I would say most of the, most of the tense conversations we've had with our LPs have been around the timeline on reporting and making sure we get something done on time.

Okay, cool. The last question I have for you is basically one is.

A big part of why we're doing LP communication is because you probably need a bunch of them for the next thing you want to do. How do you think about messaging around, getting the next fund launched and so on and so forth.

Yeah.

One of my mentors told me it's never too early to start talking about the next fund. And I kind of laughed when he said, he's like, no, no, I'm being serious. The more lead time you give people to think about it, the more receptive they'll be when you finally bring it up. And what I've learned is you've got to reverse engineer. Here's a, here's a typical example of something I see people get wrong. We have some LPs that only have three or four investment committee meetings per year. So they get four times a year to approve new investments. So if you come to them and say, hey, we're going to do A, we're raising a new fund, we're going to try to close it in the next three months. They might just say, wow, I just had my quarterly committee meeting, I won't be able to get you in front of the committee for six months. And now you've put that person in a really awkward position where they either have to call in a favor or break their process or potentially miss your fund. And so what I found is by talking about it early and setting the stage for timing, you give the LPs the chance to, to warm up their internal audience and infrastructure that, hey, like, your fund is going to come back to market in this time, this is the amount you're going to ask. So we started for our most recent fund and we started Talking to our LPs about it about nine months ago, nine months before we kicked off the process, saying, hey, we're going to launch a new fund, it's going to have this size. Here's the strategy. It's basically the same with a little twist. Would love to have you on board. What timing works best for you. And like, even little things like you might have a venture, you might have an LP who says, hey, we've made a lot of commitments this year. If there's a way I could close this early next year, it would really help me out in terms of balancing my workload. I can kind of give you an answer sooner than that, but from a process standpoint, if we could make this a commitment for next year, it would help us smooth it out and the sooner you have those. And I think it's courtesy is really what it boils down to. It's like, I think by starting the conversation early, it's a, it's a show of respect to your LPs that you understand that they have their own context and process and you're giving them a chance to help you slot into their process and timeline in a way that's most advantageous to you and most advantageous to them. And, and if you spring on them at the last minute also, you can get nasty surprises. As a gp, you can find out, well, if you have to close it this year, I'm all out of allocation for this year, so there's nothing I can do for you. And it just, again, I think the, it just doesn't show respect and consideration for your LPs, timelines and context if you sort of spring new fundraises on them.

Yeah. So basically most people don't like surprises and I would assume LPs are one of Those. Right. So go ahead and do it early. And speaking of surprises, so far we haven't talked about it, but I think it's a big topic. Sometimes you have to talk to them about things that didn't go so well.

Right.

Bad news. Do you get some thoughts?

I think when it comes to bad news, it's really important to get ahead of it and I think so what's bad news? An individual company going under that's a small percentage of your fund is not bad news that I think you need to run into your LPs about like what do I, what am I really talking about? A departure of a partner.

Major write down or change in valuation for a core position that you were counting on or had touted as one of the big fund returns drivers, especially if that information has not yet become widely known, is the kind of heads up you need to give real piece because otherwise, you know, if you've got some company that's, that's not doing well and an article comes out in the Wall Street Journal and someone, their committee goes, hey, did you know that this company that's the big return driver for such and such fund was in so much trouble, you've really put your sponsor in an awkward spot. So I think if it's a matter of personnel, if it's a matter of like a major position, if it's a ma, it sometimes it's, you had a limited partner that you were expecting to come back or commit to the fund back out, the really thorny stuff. I think you owe it to your LPs to get in front of those conversations and have them earlier and more often and give them a chance to like process and hear this stuff. I think the worst thing that can happen is an LP finds out about something really material to your fund secondhand.

Yes. Not from you in that sense? Yes. Okay. Well, this was really, really interesting. I really appreciate that. So again, Charles, thanks for your time and look forward to our next video.

Thank you too.