Technology is driving change in Venture Capital. Ideas for value-add that used to get shot down due to operational complexity are now possible. For example, auxiliary structures that would have cost a fund $25,000 per year can now be done for $5,000. These new structures and creative solutions will be a theme of the next decade.

This month, we hosted an event with Costanoa Ventures’ CFO Mike Albang to discuss their scout funds and how technology makes it possible. Mike shared his vision for the Costanoa Scout fund program, the successes they’ve had, and the value it creates for both the founders and LPs they partner with.

Here’s some quick context on scout funds before we jump in:

A strategy employed by firms like Sequoia for over a decade, scout funds are small, dedicated funds where the main fund is the sole LP. The fund commits a relatively small amount of capital to an auxiliary fund that is managed by a “scout”. These scouts are typically domain experts and may be rising investors or entrepreneurs. In working with a fund, the scouts can build their track record and establish themselves in VC. The fund will give the scout carry, take the upside of the capital commitments, and most importantly, gain access to deals they otherwise would not see. These deals create opportunities for the fund to co-invest in the company or keep tabs on them for the next round.

Why run a scout fund?

As Mike explained, there are two core drivers for Costanoa:

1. Expand the fund’s network.

2. Empower the fund’s network.

A diverse network of experts engaged with your firm can impact everything from sourcing, to diligence, to winning deals. Scout funds have proven to be a great way to build this network of experts.

Not all networks are created equal. A LinkedIn connection may be considered part of a network, but it will rarely deliver value. Scout programs are the opposite. By tying an expert to their firm through a scout position, VCs gain value-driving individuals in their network. When Costanoa chose their scouts, they were able to strategically select scouts from different backgrounds and industries that would expand and diversify their network.  

The next step is empowerment. As mentioned above, going deeper with a few experts is more impactful than a lightly-connected, larger network. Empowering experts through check writing is a great way to realize this impact. By giving them the ability to invest, VCs empower scouts to build their skills as investors, grow with the firm’s success, and contribute to the firm’s further expansion.

Why hasn’t everyone launched a scout fund?

First, there is the math of the matter. 

Historically, the cost of running a scout program was too high for most firms to justify. Funds like Sequoia have in-house legal and finance operations allowing them to spin up auxilary structures. Not many others have that scale.

For those without in-house teams, VCs had to run scout funds with traditional fund admins that require hundreds of manual hours to set up and maintain the back office. A scout fund with a traditional fund admin would cost up to $25,000 per year. 

These yearly fees add up. Costanoa Ventures, for example, runs four scout funds alongside each core fund. These funds, like most early-stage vehicles, have a 10-year shelf life. That means ten years of fees. Therefore:

The total cost to run a scout fund before was around $250,000. 

Given these costs, VC firms could not make scout funds worth it. Costanoa allocated each scout $200,000. A scout fund would not be possible if it cost $250,000. 

Through automation, Sydecar has brought this cost to $5,000 per year. Now, the math can make sense. 

Beyond the cost, there is the operational burden.

If you have run a fund or even just a Special Purpose Vehicle (SPV), you know how painful things like assembling documents, signing, and wiring can be. That operational burden, like the fee, adds up.

For a fund thinking about adding value to its core practice, many ideas get written off due to the distraction they cause. The level of operations for writing small checks is similar to that of writing larger ones, so spending time on a small check or auxiliary fund can be a waste of time.

This is another place where technology comes into play. A centralized platform to manage everything from signing to wiring decimates the workload and is the difference in whether or not a scout program is viable.

The operational efficiency gained through technology made Costanoa’s scout funds easier to manage and thus worth the strategic upside. For funds smaller than Costanoa Ventures, which has over $2 Billion assets under management, this is even more true.

Scout funds are just the beginning.

For Mike, scout funds are only one of a few common structures that are available to firms. Co-Investment SPVs and Opportunity Funds have also been common strategies of funds in the past, and they are now more feasible through technology.

These structures are all tools in the toolbelt of a firm to drive better returns for their LPs. These aren’t new structures or novel ideas. Instead, it’s the cost of execution of these strategies that have been the limiting factor. Now, as technology redefines their viability, these strategies are open to any VC that wants to bring innovative value to their LPs. 

Click here to watch the full interview. 

Want to learn more about running a scout fund? Reach out to us here.