Venture capital funds are selling their rights to invest in some of China’s hottest start-ups, resulting in a hodgepodge of fee structures for later-stage investors.
It's a trend that has evolved in recent years in China, according to Kelvin Yap, managing director at HarbourVest Partners, a global fund-of-funds firm.
“It’s rampant here in Asia,” he told an industry conference on Monday.
HarbourVest has about $50 billion under management, operating across private equity fund investments, secondaries as well as about $10 billion in co-investments.
Venture capital firms are investors that typically get involved in the very early stages of a company’s life, most likely during its Series A or Series B rounds of funding.
And as early backers of a company they tend to accrue pro-rata rights to invest in subsequent financing rounds.
Most venture capital funds scatter their investments in small chunks and often don't take up their full pro-rata entitlements as companies mature and grow in value. Investing in older companies, in any case, would likely fall outside their mandates.
So they’ve worked out another way of making money on those rights.
“A good percentage of this VC community try to package that opportunity as another product,” HarbourVest’s Yap told the audience at the SuperReturn Asia private equity conference in Hong Kong.
HarbourVest is a global investor in later stage venture capital deals, also called growth-equity financing rounds. The firm at times takes a lead and may take a board seat at a company during its Series D to Series F financing rounds.
Venture capital funds usually charge their investors an annual management fee of 2% as well as a performance fee called carried interest, traditionally about 20% of any profit but potentially up to 30% -- so called premium carried interest.
When these funds, or General Partners (GPs), ask their own investors, or limited partners (LPs), if they would like to buy the rights and co-invest alongside them they usually offer no management fees as the LP is already an investor in the main fund.
They do, however, ask for a premium carried interest, Yap said.
“I don’t blame the GPs for being commercial,” he said, but “we would like to see more alignment between the GPs [investing in the company]”.
This sale of rights has created a situation where the same investors in a company are paying different levels of fees, which may create conflict on questions such as when the portfolio company should seek an initial public offering. The investor that takes up the rights may be paying no management fee and a higher performance fee while later-stage funds may be paying management fees and a lower performance fee.
The practice also has the potential to displace investors that a company's management might want to bring on board because they could add significant value when a company is growing quickly, another venture capital investor told FinanceAsia on the side lines of the conference.
Founded in 1982, Boston-headquartered HarbourVest invests globally. In the US, where the firm has made hundreds of private equity investments, Yap said he has not seen this phenomenon.