Sharing Carried Interest & Deal Scouts
AngelList’s Deal Partners' incentives feature will expand the number of participants in startup investing.
As an angel investor, I love to get involved with helping founders, especially during the early stage of fundraising. Given the importance of building connections in startup investing, there is no better alignment (and my satisfaction) than personally introducing founders to fellow investors that could lead to potential investments.
On July 7, 2021, AngelList introduced Deal Partners, a new feature that provides the flexibility for any fund manager to share the carry or carried interest at the deal level with anyone.
What exactly is Carried Interest?
Carried interest is the percentage profit that goes to the lead investor, typically a fund manager or a syndicate lead. Let’s use AngelList’s example:
A lead investor wrote a $100K check to participate in an early-stage startup’s seed round and created a deal syndicate in which you invested $5K.
The lead investor charges you the typical 20% carry or 20% of the future profit for your investment.
Let’s assume that the startup has a successful exit, and the distribution is worth $100K.
The lead investor gets 20% of the $95K profit ($100K distribution - $5K initial investment) or $19K.
You will receive the $5K initial investment back plus 80% of the $95K profit or $76K for a total of $81K.
Carried Interest Share Economics
Let’s assume that you referred the deal to the lead investor instead of investing in the syndicate deal.
A lead investor wrote a $100K check to participate in an early-stage startup’s seed round, and you will get 25% of the carry for helping to source the deal.
The lead investor charges the typical 20% carry, of which you will get 5% (25% of 20% carry).
By sharing the carry with the lead investor, you gain the equivalent of $5K investment (5% of $100K) without writing a check.
From what I have seen so far, you must earn the carried interest by making a successful founder introduction and making a compelling case of why you think the opportunity represents an attractive investment. The terms are often non-standard and negotiated behind the scene.
Insider Game
Before you get excited, sharing carry is rare especially given the lucrative nature of its economics, as highlighted in the example above. There isn’t any lead investor that I know who is generous enough to share the carried interest regularly.
Before Deal Partners, carried interest sharing is an insider game among the established investors and well-connected founders and often took place behind the scenes with side letters.
It’s rare to see anyone who doesn’t meet the standard of accredited investors and actively participate in startup investing and fundraising benefit from sharing a carried interest.
Although I haven’t participated in any share carry yet, I have indirectly benefitted from making a successful referral on a deal that I invested in earlier this year.
One of the earliest deals that I ever invested in was H3X, a Y Combinator startup. Since the investment took place before Demo Day, I was fortunate to be in a position to help the founder with the fundraising process. Since I was already active on AngelList, I know some key investors who love startups in deep tech.
After making the intro which led to a meeting, the investor asked me for my thoughts on the company. In response, I shared my investment notes of why I invested and some deal risk analyses. After the investor made a considerable investment, the investor rewarded me by waived my carry interest in a prior syndicate deal that I invested. While this was unexpected, it works for me because I happen to be actively investing in startups.
Venture Capital Scout Programs
Carried interest sharing in venture capital is an even more exclusive insider game, where it takes place in established firms (Sequoia, Accel, Kleiner Perkins, etc.) scout programs. According to this, scouts (often well-connected entrepreneurs and occasionally academics) can invest money in startups ($25-50K at seed stage) on behalf of venture capital funds.
Some of the investors I admire, such as Alfred Lin, Sam Altman, and Jason Calacanis, came from such scout programs that helped them to build their respective venture careers. Jason’s own successful early $25K investment in Uber was funded by Sequoia, per this article.
As discussed in detail here, Sequoia runs one of the most prominent scout programs. With a $195 million fund, Sequoia invests in seed rounds by leverages its network of scouts to expand the firm’s “access to founders and operators.”
According to Jason Calacanis’ book Angel, “Sequoia Capital would put up the money and twenty carefully selected founders of technology companies would pick founders they know to back. The returns would be split: 45 percent to the Scout who made the investment, 50 percent to Sequoia, and 5 percent in a bonus pool to the other Scouts in the program.”
Expand the Number of Players in the Startups Investing Game
Instead of seeing the potentially lucrative carried interest being shared among insiders behind the scene, Deal Partners has the potential to expand this incentive to a larger group of participants. With this feature, any fund manager has the flexibility to share the total carry or carried interest at the deal level with anyone. Given this, I can see knowledge workers in tech startups, who might not necessarily meet the standard of accredited investors, will be incentivized to participate in the fundraising process. Product managers, who might know other founders, can be deal scouts. Engineers or designers who discover and test new tools or products related to their work have motivations to learn about startup investing and refer founders to their network.
At the same time, Sahil Lavingia, a well-known startup founder and investor, launched his scout program in parallel with Deal Partners launch. You can read more below and here.
Solo Angels, Part-Time Fund Managers, Rolling Fund Trends
Once I began to invest in startups late last year, I started to pay more attention to the significant trends impacting the landscape of early-stage investing. Here are some notable trends:
Solo angels
Part-time operators/investors
Growth in syndicate deals on platforms such as AngelList
Equity crowdfunding on platforms such as Republic
“Seed” fund and super angels putting together SPV for the late stage to pre-IPO deal opportunities
Some of the key takeaways from these trends include:
There are many more varieties of “fund managers” in early-stage investing compared to the past.
There are more options and access to raise money from limited partners (LPs) to invest in rolling funds (with lower minimum capital commitment and flexibility) and SPV, created for specific deals.
Strong network effects where different angels, operators, and fund managers invest in each other funds, where there is more teamwork in deal flows.
Solo angels and part investors like Sahil can quickly raise money with their strong connections and huge Twitter followings.
Investing in public seems to be a noticeable trend compared to the opaque nature of startups investing in the past.
On the other hand, these emerging investors have to juggle raising funds from LPs, sourcing deals, and investing in startups (and often running startups), which take many time commitments.
Therefore it makes sense to outsource some of the work related to finding promising startups to invest in so that these emerging investors can do more and bigger deals in the future. Given this, Deal Partners makes sense for these investors to start thinking about building their version of scout programs by leveraging their networks.
I think all the trends and possibilities will make investing in startups more accessible to everyone, especially non-accredited investors. By providing incentives or skins in the game, anyone who is a “High Earners, Not Rich Yet” (HENRY) who is curious about startup investing will have the chance to work towards a “freeroll” in the form of carried interest sharing to get them in the game.
So if you are one of those HENRYs, start learning about investing and get connected with founders and investors today!
Thanks for reading. Feel to comment if you have any questions or have thoughts about this. Would you please share if you know someone who might find this post helpful?
Until next time,
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Update: I just got notified that I got (unexpected) selected to be part of Sahil’s scout program first cohort after this post was published. It will be an exciting experience.