Notes from an interview: What do Big Society Capital look for in emerging managers?
Last week we held our 4th FutureWorldVC event - this time virtual. Diverse VC’s from around the world joined me as together we grilled Dougie Sloan, Investment Director at Big Society Capital, a leading impact fund of funds in the UK on what they look for in emerging managers.
Big Society Capital (BSC) have backed Ananda Impact Ventures, first time fund Eka Ventures, Ascension through the Fair By Design Fund, Mustard Seed, LGT Impact Ventures, Nesta Impact Investments, Bethnal Green Ventures and Connect Ventures. We were all intrigued to understand what we might do to get added to that list in the future.
I’ve taken the liberty of extracting and transcribing some of that content for you to absorb in written form.
Dougie how did you make your way into investing in funds for BSC?
My background was in strategy consulting with the Boston Consulting Group, where I became increasingly interested in socially motivated work. I joined BSC originally on secondment in 2016 and from mid-2017 I’ve been part of the investment team. For the last couple of years I’ve been leading our work in venture.
What is BSC’s investment thesis?
Big Society Capital was set up in 2012 by Sir Ronnie Cohen, who founded Apax, with a mandate to grow the market for social impact investing in the UK. We were capitalised with £600m in balance sheet capital - made up of £400m from dormant bank accounts and £200m from four shareholder banks. We invest this in funds only, no direct investments. To date we’ve invested in just shy of 100 funds. We start with the social issue and look at the enterprise models that can help improve that, then the type of investment that they need.
The venture aspect is one part of that as an organisation and represents 10-15% of what we do. Our objective is to develop an ecosystem that both nurtures and scales innovative ways to tackle social problems. We believe the tech-enabled venture way of making change can be transformative with the right business models, the right intent, and in the right context. To achieve this we believe you need to take a systems approach - seeking to tilt the overall ecosystem to more fully consider how much impact it is having and could have.
To bring that about our main lever is to partner with VC fund managers we believe have the right values and skills and we augment that with connections to other LPs, impact know-how, and fostering networks. We bring these various levers together in two ways.
The first way involves working with established VCs who bring values alignment, an interest in impact, as well as serious credentials in VC investing in the mainstream. Here part of the fund is likely relevant to our impact thesis, and we are trying to demonstrate what is possible to the mainstream VC market. Our recent investment with Connect Ventures would be an example of this approach.
The second way involves working with VCs who are pioneering innovative or less proven models trying to reach underserved impact startups or are bringing a really focussed impact lens. Ananda Impact Ventures, who have been investing in impact startups across Europe and are now on their third fund, would be an example of this second approach.
How do BSC approach the assessment of new funds? Do you have a framework?
Across all asset classes, we assess proposals against four dimensions:
How the proposal delivers a positive impact on people’s lives
The systemic change it may help create
The financial/risk return
Team ability and values alignment
In venture, we’re looking for fund managers that can reach a good level in venture investing skills, impact skills and fundraising from others.
There are three layers we use to help us assess these:
Compelling strategy for delivering strong impact and financial returns
Edge in executing that strategy, which likely includes aspects of team, brand, or scaling expertise – and may be evidenced by financial and impact track record
Ability to repeatedly deliver at high quality, which includes aspects of investment process, impact process, and longer term firm-building
What is the best way to get in the room with BSC?
We try to be approachable so cold emails are as good a way as any. My email is on our website. You can reach me on Linkedin, at conferences or through warm intros too, of course.
What is the fund size you typically invest in and what is your appetite for concentration risk particularly in first time funds? Often the minimum ticket size is driving up the fund size for first time managers when maybe they should be raising smaller funds.
We normally invest between £3-5m. This usually makes us one of the half-dozen bigger cheques in a fund but we’re not usually the biggest investor. Rather than concentration we think about minimum viable fund size, so we rarely invest in funds smaller than £30m and virtually never less than £20m. We most like to invest in funds between £30m and £80m. Some may call these micro VCs but we prefer to think of them being disciplined on fund size, particularly for early-stage investing.
What makes you sceptical when assessing new opportunities? Where do many managers go wrong in the fundraising process?
Three things that most come to mind:
Overclaiming: An impact edge that isn’t there or selectively cutting a track record to make it look better than it might be. That raises some flags.
Undifferentiated thesis or lack of edge: Not clear how their offering will drive financial returns and impact together or why they are the people to be doing it.
Lack of planning for the long term: We think the best managers think about building the firm as much as the fund. This covers culture, hiring, developing people. Often emerging managers may have underthought this aspect.
How does BSC structure the investment decision making process?
The informal process
The initial meeting will focus on getting to know you: the strategy, the team, and the impact you want to achieve. The second meeting will usually dig into the portfolio and how these examples demonstrate the impact you’re looking for - as well as your strategy and the value add you offer. At this point we’ll make a decision on whether to enter into the formal process for this particular fund. If we don’t proceed at this point we would give feedback on what we’d need to see to look again in the future. This informal process can last from a month or two through to a couple of years, depending on the relevant fund raising timelines and how long we think we need to get to know the team.
The formal DD process
There are two decision points with our investment committee. A ‘pre-DD’ strategic screen and a final decision 6-8 weeks later with a formal investment memo. Between these touchpoints there would be the usual DD activities: data requests, document reviews, workshops on specific topics, referencing, and a fund manager presentation to the investment committee. This is followed by the documentation phase, legal negotiation, and portfolio onboarding.
How does this differ when re-investing in existing managers?
We follow broadly the same process, with the same dimensions of analysis and formal decision points. We have a deeper set of data points in relation to managers we’ve worked with before and this lets us be more targeted in DD. This will often include comparing plans against actuals for the current fund or funds, and going deeper on referencing with portfolio founders.
What do you think of GP commits today? How do you look at what is reasonable and what is required? Is it individual and context based? What if anything do you think needs to change in this area?
Building alignment between the GP and the LP is really important. The GP commit is one way of doing that - but it’s not the only way and it’s not the most important thing for us. We typically look at it in relevant context, case by case as something that’s meaningful for the individual and this can vary massively. Market is 1%, we’ve seen 0.5% to 2% or more depending on different proposals. There does need to be wider considerations of barriers to raising VC funds and GP commits are absolutely part of that. Thinking of how long it takes to raise a fund, at this point 18 months or more, and the burn rate through that time - it can be a really substantial amount of money. I do think there needs to be more done to open that up in VC more broadly.
When looking at emerging managers what learnings do you have from them in terms of what separates the good from the great?
To put things into perspective, around 75% of our investment across all asset classes historically have been into first time teams, funds, or managers. We see a lot in this area, and have developed a specific tool we call the ‘Building Blocks’ to help emerging managers develop.
In venture, we look for the same things in emerging managers as we do more broadly: strategy, edge, and ability to deliver repeatedly at high quality. We can start to assess that by the time of the raising a second fund through:
Execution in line with stated strategy
Stable senior team
Early signs of portfolio success
What separates the great is that they bring things that help them achieve these:
Depth of thought on strategy and edge helps to maintain that consistency over time - or to provide a compelling reason that they can talk through for having evolved that thesis.
Depth of thought on firm building goals and approach - and, critically, alignment on that across the founding partners.
Having the relevant experience to hit the ground running, as it’s often only 2-3 years before you begin raising the next fund so having some early wins and an uptick in performance will help generate LP interest.
It must be said we are always trying to learn from managers in venture ourselves, as we are effectively an early-stage investor in fund managers in many cases. As part of this, we try to share learnings across our portfolio from emerging to established managers and vice versa.
When considering backing a fund manager, how important is investment track record and how much do you look at the track-record of the team vs track record of individuals within the team?
To put this into context, track record is an important topic but it’s not the be all and end all. We typically look at fund level performance and individual level performance. Individual performance is particularly important in emerging managers or ‘spin out’ managers - coming from an established VC but launching their own firm for the first time.
We look at the quantitative indicators that you would expect, and benchmark them against the relevant vintages. We also think it is important to consider the context: how relevant is the track record for what you’re looking to invest in now, how long is that track record in terms of time, how deep in terms of number of investments. From an individual perspective in particular, we take into consideration the platform the individual has been investing from, whether as an angel or at a larger fund with an established deal flow, and we look at attribution. This includes looking at who led investments and sat on the boards but also who sourced them, seeking to understand who is building those important networks.
What do you think about intra partner dynamics in VCs and about VC firm culture?
Values alignment is possibly the most important thing for us. Assessing partnership dynamics and firm culture is a big part of that. We look for values in line with BSC’s own, and often place a particular emphasis on:
Purposefulness and impact intent
Openness and intellectual humility
In practice this often includes healthy challenge and debate between partners, having good feedback processes, and being very transparent communicators. Diversity is an important aspect of this for us. We’ve not invested for some time in a venture firm without a female partner, for example.
Do solo GPs raise a red flag?
This wouldn’t prevent us from making an investment but it means the bar would be raised. Partly because we think that team dynamics are really important for high quality decisions, and partly because the longevity of the firm over multiple fund cycles is more likely to happen in a healthy way when there is more than one general partner.
Looking ahead, what changes do you wish to see in VC and what are you doing at BSC to support this now/in the future?
As we talked about earlier, we’re trying to help build a venture ecosystem that nurtures and scales innovative ways of tackling social problems. To put a bit of flesh on that bone, we think this looks like:
A large and effective group of impactful startups tackling a broad range of issues
High-calibre fund managers providing investment, impact skills and venture skills to support impactful startups
An increasing numbers of investors or LPs providing an appropriate amount of capital to support this ecosystem
Having rigorous and proportionate impact practice to help guide decision making
We’re trying to tilt the ecosystem in this direction through pursuing the strategies we talked about earlier: investing with established VCs and impact-focused VCs, while bringing other tools and support to bear alongside.
Do you think 10 year fund structures are long enough for the systemic impact you look to achieve? Any ideas for iterations on the current venture model?
Systemic change is so hard to assess and evaluate, a lot of the time we are working at the level of hypotheses. We’re learning about this all the time, and at the moment tend to look at it in two ways: investment systems such as venture, and ‘social issue’ systems such as housing or health.
At the investment system level we tend to see raising cycles being more relevant than the 10 year fund life - as the 3-5 year cycle of raising new funds presents an opportunity to introduce new approaches. As for the issue systems, we tend to see that being more about the startups themselves than the funds. This can take a very long time or can happen very quickly, but in either case isn’t that closely linked to the 10 year fund structure.
In terms of new or different models, there are three that come to mind. Firstly, we’ve invested in an evergreen fund at the growth stage, and I think we’ll see more funds like this over time. A second area we’re seeing more of in Europe is venture building like EF, Zinc, and Antler. Thirdly, a model that’s more established in the US and becoming more interesting in the UK is revenue based investing, and we’d be interested in seeing more models like this with an impact lens.
What’s your view on the LP industry and approach to impact investing?
We are increasingly seeing LPs integrating ESG aspects in their investment processes, looking at environmental, societal, and governance aspects. There are fewer going beyond that to actively seek and evaluate social impact currently, but I think it will develop in time. For example, in European VC something like a third to half of all capital goes through the big state LPs like BBB, EIF, and KfW in Germany. I believe many of them are thinking about how to integrate ESG and impact aspects in how they look at funds. I don’t think impact has fully arrived yet, but I think it will be odd in 5-10 years for an LP not to ask about impact in their investment process.
Have you seen anything or would you like to see - that gets you really excited particularly on the impact side?
I’m excited about our recent work investing with established mainstream fund managers, bringing their expertise to help impactful startups to grow - and signalling to the wider market that it is possible to generate strong financial and impact returns together in the right circumstances. I think this could unlock real impact at scale in areas like health, education, or financial inclusion.
I think revenue-based investing that I mentioned before could be very exciting. Fund managers getting the right mix of skills and expertise in both impact and venture - combined with the right group of LPs - could be challenging but the potential is really exciting. Some areas like mental health can take multiple years of academic studies to build the evidence required to be implemented into the NHS - so the growth curves don’t match to traditional VC expectations on time to return. Revenue based models might be a better alternative for these types of business models, and could unlock the potential of a large group of currently underserved impact startups.
Why are diverse VCs important to you?
Diversity is a really important aspect for us. We’ve turned down funds on a diversity basis in the past. It’s included in every DD process, and after investing we work with fund managers to understand how they can improve their approaches. We have a lot to learn ourselves, too, and we are working on this within BSC on an ongoing basis.
There’s heaps of value that diversity can bring to the table in terms of having empathy with founders and their lived experiences as well as those of people who might use the products they build. There are all sorts of benefits associated with representing the group that you are looking to serve. Our thinking here is underpinned by that dictum that ‘opportunity is not evenly distributed but talent is’ - and we repeatedly see that being borne out.
A big thanks to Dougie, my co-hosts Sarah Melaney and Brown Rudnick, and special thanks to Yvonne from Impact X for the inspiration for the event and goes without saying thanks to all those of you at home who attended - the future partners of venture capital.
We plan to cover raising your own fund, portfolio management and career development to Partner level in future events. If you have been working in Venture Capital for 2+ years and from a diverse background please sign up here and let us know which company you work for - we hope to see you at the next one.