The subscription model, which has been successful in most business areas, is also actively manifesting itself in venture capital. Rolling Funds attracts investors with its simplicity, convenience, and the ability to bypass certain limitations of traditional funds. Such revolving funds make the venture industry more accessible to new players, which helps to increase funding for the start-up industry, increase the number of innovative projects and accelerate their implementation.

So, let’s look at the differences between Rolling Funds and classic funds, as well as the advantages and disadvantages of a new investment tool.

The concept of rolling funds

The new venture investment mechanism began to gain momentum after the launch of its mobile fund by AngelList Rolling Funds in early 2020 (also known as “rolling”, “turnover”, “rolling”). The investment tool allowed investors to raise funds much faster than usual to invest in potentially profitable start-ups.

Rolling Funds are funds that offer the investor to make a quarterly subscription, the price of which is an investment in the project. While traditional ventures raise funds to finance a startup at once, investments are made to the mobile fund on a regular basis (quarterly).

The investor can operate with smaller amounts on an ongoing basis, he periodically receives a report on investments, has the right to regulate the amount of the subscription. The investment system includes all the necessary legal, accounting documents, marketing tools, tracking. Let us consider in more detail the principle of operation of the investment mechanism.

Principle of operation

Rolling Funds operates on the principle of streaming services: the amount for a subscription (investment) is debited quarterly. This frees the manager from the constant search for sources of new injections: you can quickly raise funds and invest in promising projects.

In addition, the investment mechanism makes it possible to bypass some prohibitions. In conventional US funds, the number of investors should not exceed 29 people – this is the reason for the search for wealthy investors with significant material resources by managers.

Rolling Funds are not limited in the number of investors, which makes it possible for a larger number of participants to enter projects with a smaller check. The amount of the minimum subscription can be only $1-2 thousand per quarter (on average $10-20 thousand). This makes the venture capital market more accessible to new players and contributes to an increase in investment. At the same time, Rolling Funds has the right to openly call for investments, which ordinary funds cannot afford. But certain rules also apply to the new investment mechanism: investors must be accredited, which is confirmed by relevant documents.

Commissions are included in the subscription price. The amount is set by the funds themselves. For example, AngelList has 5% fund fees and 0.15% for administrative costs.

Shares in Rolling Funds are distributed once a quarter: if the amount of investments for the 2nd quarter is debited from the investor’s account, it will not be related to the investments of the 1st or 3rd quarter. Money not invested by the manager during the subscription period is carried over to the next period.

The amount of investment can be increased, reduced to the minimum approved by the fund, or the subscription can be canceled. It is important to understand that the new investment vehicle is more volatile than the traditional one. The investor can refuse to participate at any time and not renew the subscription for the next quarter. To avoid this, many Rolling Funds set a minimum period of cooperation – mostly it is 1 year (against 10 years in conventional funds). The investor then decides whether to invest on a quarterly basis. 

Structure of the investment mechanism

Consider the individual elements of the structure of the new investment mechanism:

1. Management – legal issues, organizational and administrative functions are assigned to the manager. He is responsible for the preparation, verification of documents, work with banks, the formation and submission of reports to the tax office. The manager is engaged in marketing, development, attraction of projects and investors, organizes the transparency of work for participants. For this activity, Rolling Funds collects a commission from subscribers.
2. A mobile fund organization is a series of limited partnerships. At the end of the subscription period, the participant will be offered a new fund with almost identical conditions. This guarantees the openness and transparency of the structure for new players.
3. The amount of the subscription is approved by the fund. For example, in AngelList, the contribution in 2022 ranges from $2.5 thousand to $167 thousand per quarter.
4. Commissions – differ for individual Rolling Funds, as they are set by them independently. Each structure charges an administration fee. Many introduce fees for managerial work. In addition, carry is kept – mainly 20% of net profit.

Differences between Rolling Funds and classic venture funds

To understand the differences between the two investment mechanisms, it is enough to compare the above key aspects of the work of Rolling Funds and the principles of operation of conventional funds. Recall the features of the work of standard ventures:

1. The life expectancy of a classic fund is 8-10 years. This period is considered optimal for the development of the company from Seed to IPO. The minimum period of cooperation for most mobile funds is 1 year, which creates certain problems. It is quite difficult to grow a successful startup over such a period, which creates risks for both the investor (loss of investments) and for other participants in case of unsubscribing.
2. An ordinary venture actively invests in the project for the first 3–4 years, then waits for liquidity to come after the startup goes IPO or is sold to another market participant. At the end of the life of the fund, money is returned to investors with dividends with retention of carry – mainly 20% of net profit and up to 2% commission for its activities.
3. Fund managers – General Partner, partner investors – Limited Partners. In standard US venture structures, there can be no more than 29 LP, there are no such limits for Rolling Funds.
4. Investors immediately send money to the fund or undertake to do so in the future at the request of the GP.

Rolling Funds position themselves as structures that make classic venture capital more flexible. According to AngelList CEO Avlok Kohli, “ Rolling Funds is what venture fund structures would look like if they were created in the software age. ”

From the differences between standard and revolving funds, one can formulate the advantages and disadvantages of Rolling Funds.

Advantages

Instead of raising all the money at once, revolving funds collect it in smaller checks once a quarter. This is the reason for the most obvious advantage of the new investment mechanism – the ability to regularly collect money (quarterly), greatly facilitating fundraising for the manager.

According to AngelList, Rolling Funds needs $4.68 million less than a classic fund to start investing. To invest $300,000 per quarter over four years, a regular fund needs to raise $5 million all at once, while a Rolling Fund manager only needs to raise $312,500.

One of the main advantages of the new investment mechanism is the ability to start working with a small amount of investment. GP does not need to raise funds during the year and more intensively.

This opens up new opportunities for various investors, including those who have not previously been involved in venture capital. Conventional funds raise funds behind closed doors, attracting experienced and wealthy investors. Rolling Funds, by lowering the barrier to entry, allows many interested parties to test themselves in investments: companies, serial businessmen, startup founders, and so on.

Another advantage is that the Rolling Fund manager has the right to decide when to attract investments. Money can be collected gradually and spent as needed. For example, you can raise $ 300 thousand in January and, if there is no need, do without raising funds until a certain point.

The traditional fund immediately receives all the money from the LP (or liability): it must invest it or return it. This motivates managers to spend all the investments received.

The investors of the moving fund share the profit only from the part of the portfolio in which they have invested. That is, independent portfolios are organized quarterly, and LP has the right not to renew the subscription (investment) in the next period. In a conventional venture, investors participate in the aggregate return of the fund’s total portfolio.

Among the advantages of Rolling Funds, we also mention:

• the opportunity to speak publicly, attracting investors to invest; 
• no restrictions on the number of investors;
• investment flexibility – partners have the right to quarterly increase, decrease, stop their obligations;
• increased control over fees;
• no need for administrative work;
• growth of opportunities for the start-up industry due to the increase in the number of investors and constant investment.

Disadvantages

Venture building is always associated with a high probability of failure and uncertainty of the result. The same risks remain for the new investment format based on the subscription model.

The main disadvantage of Rolling Funds is considered to be a short period of cooperation (usually 1 year), during which it is impossible to grow a successful company. The investor may well be left with nothing if he refuses to renew the subscription and skips the fund’s investments in a potentially profitable project. A ten-year term of a conventional venture allows you to go through a full development cycle with a startup.

In the example in the previous chapter, we considered that Rolling Funds requires much less investment to start investing than a conventional venture ($312.5 thousand versus $5 million). But at the same time, no one can guarantee that the manager of the revolving fund will be able to raise the next funds in the next period, when the initial capital runs out.

The disadvantage is also called a decrease in motivation to work with the manager of Rolling Funds due to small amounts of investments. Traditional funds invest all funds received at once or return them. To avoid a return, GPs are actively looking for projects for funding, giving it all their time. A traditional venture is more interested in the success of the project, trying to help not only with money, but also with connections, consultations, support, and so on (for example, within the framework of accelerators, incubators, startup studios).

Prospects

A list of active mobile funds can be found on the AngelList website. For example, in the first position, you can see the company Footprint Coalition, owned by actor Robert Downey Jr.

In the first half of 2020, 70 funds were organized to implement the subscription model. Despite forecasts by AngelList analysts to increase their number to several hundred, in 2021 the total number has decreased to 60. The company does not disclose the financial performance of the work but calls the speed of development of the investment mechanism promising. Most signed investors are from China, UAE, India, and Canada.

The development of a new investment model could have a significant impact on the entire venture capital industry. Typical trends are:

1. Growth in the number of venture investors as a result of lowering the barrier to participation, the absence of a limit on participants.
2. Increase investment in promising projects at an early stage.
3. Increasing competition in the investment environment for potentially profitable start-ups. This will give impetus to the global development of innovation.

Rolling Funds offer significant benefits to participants: founders are given the opportunity to receive constant cash injections, investors are given the opportunity to diversify startups and invest with a smaller check.

The structure of the subscription investment model is more flexible than standard mechanisms. An ambitious novice manager can start with small checks, while still having every chance to prove his own competence and enter the big leagues.

But do not forget about the inherent risks of the startup industry in general and Rolling Funds in particular. In a short period of cooperation, the possibility of an investor refusing to renew a subscription creates certain difficulties. Risks can be avoided only in one case – by offering a product that the market needs, which has empirically proven its ability to relieve the consumer’s pain.

Source | StrategiNext