Issue #32: Rolling Funds in Search, Part II

I’ve continued to think about the rolling fund concept and I’m going to build on some of the questions I brought up in the first issue on rolling funds for search. If you haven’t read my first article on rolling funds, I recommend reading it first as this article is a follow-up to those thoughts.

In the first article, I brought up the issue of reporting:

“How do you share news about your portfolio to investors with different asset mixes? If the fund is 2 years old and has had 8 quarters of capital contributions, do I write 8 different versions of their 2nd annual letter for the 8 different combinations of investments? Perhaps I write a short blurb about each searcher and a software tool, based on an LP’s investment mix, pulls the blurbs about searchers the LP has invested in together in one document? A summary of the year can be written for all investors and the portfolio commentary is pulled together based on asset mix. I think reporting is something that can be resolved, but it will be more complex than a normal fund.”

I still agree that, while reporting will be more complex, it’s something that can be solved. An overview of the portfolio can be written and distributed to all LPs and investment specific write-ups can be distributed based on LP portfolio construction. It may get messy and will surely be fine-tuned over time with software, but I’m not terribly worried about this challenge.

Another challenge previously mentioned is always being in fundraising mode as a result of the rolling fund dynamics. While the act of fundraising involves pitching and scheduling lots of meetings, the core of the activity is communicating with current and prospective LPs. And communications with LPs are ongoing and never stop. A manager writes quarterly letters, takes calls with prospective LPs, and has frequent conversations with current LPs on performance, introductions, capital raising. I’d argue a manager is always in fundraising mode even after the fund has closed to new investors.

Matching capital inflows and outflows was also a concern, particularly when investing in traditional searchers:

“But what happens when a traditional search I invest in finds an acquisition and needs $500k-1m within a few days or weeks? Unless I allowed capital to build up for a few contribution cycles in the fund, potentially upsetting my investors for doing “nothing” with their capital in the meantime, there won’t be capital available to take advantage of the fund’s investment in the search phase by contributing more capital at a stepped up basis.”

I think a rolling fund could approach investing in traditional searchers in much the same way as a normal fund. Invest in traditional searchers and bookmark existing and, in the rolling fund case, committed future contributions to the search acquisition. Investing in a searcher’s search phase is only a small fraction of the expected position size of that investment. I don’t see any reason a rolling fund couldn’t invest with the same expectations and set aside capital for the expected acquisition down the road. All in all, this is a resolvable issue.

Another item mentioned was disparity between small and large LPs:

“Another potential driver of return disparity between small and large LPs is investors in one capital contribution period won’t benefit from investments made prior to their contribution or after their funds are invested. In contrast, when a small LP invests in a normal fund, they have an interest in all prior and future investments from that fund. If a small LP is only able to contribute for 2-3 capital contribution periods, they are going to have a more limited mix of investments than LPs who are able to make consistent contributions over many years.”

This could be an issue for smaller LPs, but a smaller investor can stagger their investment over a number of years to negate part of this downside. In fact, smaller investors may do better in a rolling fund than a traditional fund because of the model’s ability to take investment dollars over time instead of requiring them all at once.

Say you’re a small LP with $100,000 available to invest in a search investment fund and you’re adding $50,000 to that number annually from your household income. If you’re investing in a normal fund, all you can do is contribute the $100,000 today and save the additional $50,000 per year in a savings account for the next fund, where it will generate no return in the meantime. But in a rolling fund, you can contribute capital every quarter as you earn it. Your capital doesn’t have to idle in savings account and can be put to work sooner.

This also represents the tremendous pro for launching a rolling fund. The fund can start small, build on reputation more quickly, while giving access to search investments to investors who normally aren’t able to deploy capital in the space. I understand there are also expanded marketing abilities with a rolling fund, but I need to conduct more research before commenting accurately. The concept of a rolling fund for search has me intrigued and I’m continuing to research the concept and applicability to search. Please let me know if you’re also interested in the concept and let’s chat!


Think Like an Owner Sponsors

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Capital Notes

  • Sahil Lavingia gave a presentation on his rolling fund that I highly recommend.

  • Pomp on Twitter wrote a really inspiring thread on Joe Rogan that I read several times. It’s pretty amazing what he’s been able to do and Think Like an Owner can only dream of getting to the level he’s achieved.

If you found an interesting article, podcast, or interview that I missed, please let me know, I’m always looking for interesting stuff.

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