Orchid Partners is a Venture Capital firm being founded by give general partners Todd Krasnow, Susan Pravda, David Friend, Bill Nelson and Jeff Flowers – who have known each other for many years in various professional and personal capacities. All four partners are driven and committed to this venture and bring the strength of prior experience in venture capital industry, entrepreneurship, operations (hands-on running of businesses), raising capital to fund ventures, familiarity with the deal making process on either side of the table, as well experience in multiple industries.
Moreover, their strengths are complementary such that they overcome individual weaknesses – eg.
Friend prefers to be a visionary and rainmaker, while Krasnow has operational expertise and Susan holds the fund together. The timing and personal goals of the partners also align during the founding of Orchid. However, neither individual has experience being a general partner in a venture capital fund, and the group needs to work together cohesively and decide the best strategy for the fund.
Individual strengths and weaknesses are detailed below
Sits on boards of companies Innovator, with varied interests and respected public figure, leading to network across horizontal strata of society
Market savvy and ability to understand and foresee technology trends Well experienced entrepreneur having served as CTO of three companies Innovator and holder of patents in technology sector
Jeff Flowers Due diligence expert for technology retreated aspects of VC firms
Each of the general partners committed $2 million towards the fund. Initially, Orchid directed its fund-raising efforts towards personal contacts of the partners, wealthy people they believed may be interested in investing in their firm. Friend could get commitments of $50,000 to $500,000, but that was miniscule in comparison to their initial target of $50 million. The major problems with this approach were: 1. During the first round of fundraising, it is difficult to convince individual investors of the viability of the deals the firm has in the pipeline and hence get their buy-in
without having other investors. It leads to a cause and effect problem, where people are reluctant to invest since they do not have sufficient funds from other investors already. Also, individual investors typically invest smaller amounts as compared to larger institutional investors.
Also, Pravda, Krasnow and Flowers were not able to spend dedicated time to fundraising activities, since they were working full time. Thus, initially, the effectiveness of fund-raising activities was limited by Friend’s activities alone. Once they realized that these initial efforts may not be so effective in raising the requisite amount, they decided to target institutional investors, raise a large chunk of the target amount and then approach individual investors for the remaining amount.
Similar to other industries, VC fund investors also constitute of different segments, i.e. innovators, early adopters, resistors (laggards). This had a huge implication on Orchid’s fund raising activities. It was essential for them to raise the initial few millions through institutional investors enough to reach critical mass, following which the laggards and the other skeptical investors follow into innovators’ footsteps. Thus, they should engage with friendly institutional investors at first. This essentially meant two major changes in their fundraising strategy:
The company started with the assumption that other VCs would be an excellent source of new deals. It believed that the expertise they had in varied sector and emerging technologies was not very common amongst VC circuit and they could pick up companies in the early stages of operation and needed small funding. Friends from other VC companies would suggest the companies that do not fit their criteria or need small funding in series A. Orchid partners felt that the approach was in their best interest considering that fact the market would not trust a new VC fund start up easily and established limited partners might not take a chance with such companies.
Orchid Partners were following practices common for deal sourcing in the venture capital universe. Their strategies dealt with by focusing on long-term relationships built with sellers and management teams in the local region of New England. To start with, Orchid’s plan to leverage industry contacts of its partners and VCs to provide a pipeline of deals might be good in the short run. In future, as the size of the fund grows, sustaining a steady pipeline would be rather difficult.
Orchid devised a strategy to concentrate only the areas that it was knew best since each partner had unique background and was a specialist is their field. The approach was to assign a partner to every sector in which the company had expertise. The partner was then responsible for carrying out the due diligence and also comprehensive study of the industry and exit option of the firm. The issue with this approach is that the partner already has heavy involvement in the deal before pitching it to all the partners. Since the firm size was small and every partner was an expert in their own field there is a chance that they could get too attached to their views and push for the investment. In addition, this model assumes that the partner would be able to analyse every aspect of the business i.e. taking into consideration the legal, financial, administrative and operative aspects of the business which might not always be feasible.
Orchid Partners could build a specialist team trained in outbound origination programs who would be experts in scouring industry forums and the upcoming internet. Matching historical deal to the industries in focus with investment financing from banks might also help in generating leads from financial institutions. Dealing with Limited Partners
In 2003, the PE industry is just recovering from a downturn and the Early-stage investing part of the market is largely underserved. Also, the Orchid Partners team is well diversified and has strong experience with them w.r.t. growing, managing and turning-around businesses. However, since their fund is new and doing the first round of fundraising, they don’t have the liberty of being too demanding from the Limited Partners in terms of the deal terms. It is advisable that they focus on the following deal terms: Fund term: The Partners should look at a fund term of at least 5-7 years which will have an investment period of 3-4 years.
They can start the negotiation with 7 years fund term and as a worst case look to close at 5. Since they are focusing on technology and technologyenabled businesses, a term of 5-7 years should be enough to close the fund. Management fee: Orchid Partners should look at management fee of 3% considering the fact that they are raising a small fund and they would need sufficient capital to hire a team, rent an office and cover other administrative costs. Post negotiation, they should look to keep this component at 2.5% at minimum.
Hurdle rate: Since the fund is new in the market, it will be advisable to offer preferential returns to the LPs before the GPs can carry a part of the profits with them. Orchid Partners should set this rate at 8%, the industry norm.
Carry: Orchid Partners should offer a straight, non-negotiable carry contract of 20:80 where-in they will keep 20% of the profits and distribute 80% of
the profits to the LPs, once the Hurdle Rate has been met.
Distribution waterfall: Orchid Partners should propose that the returns generated by exit from the investments will be distributed to the LPs in a pro-rata to amount of the LP’s money invested in the business which is being exited.
GP’s contribution to the fund: This is important as it signals the commitment of the GPs to the fund and ensures incentive compatibility between the LPs and the GPs. They should invest at least 10% of the fund size to the fund to assure the LPs that the GPs have enough skin in the game.