Very Early Stage Funds

The Very Early Stage Funds (VESF) cluster aims to explore the ways in which capital can sustainably be deployed into start-up and early-stage businesses operating in frontier and emerging markets that have limited track record and require high touch support to achieve their potential. This cluster will share knowledge and research, identify critical challenges for VESFs, and aim to accelerate and design solutions.

WHY IT MATTERS

VESFs manage small funds, often between $5M and $20M and invest between $50K - $500K in early stage SGBs that are in the pre-revenue to early revenue stages. Given these characteristics, VESFs play a unique role in entrepreneurial and financing ecosystems – they take high risk to nurture companies to the point at which later stage investors can invest to scale. They fill an important gap in the capital value chain because the type of company in focus is often too large for microfinance and lacks the profile required for traditional venture capital. Because of VESFs, early-stage businesses can access a source of value-added capital without a fully validated business model and a long track record.

However, VESFs face challenging economic models when investing in SGBs. The cost to source, perform due diligence, and manage an investment is high relative to the ticket size and risk-adjusted returns. As a result, LPs and other investors tend to shy away from this segment of the market and VESFs are undercapitalized in two ways: they lack experimental capital to test and refine the business and operating model required to serve SGBs, and they struggle to scale.

To address these issues, support is needed to help identify and validate the investment models that are most appropriate and financially scalable and to de-risk institutional investors who are not currently investing in VESI vehicles.

PROGRESS TO DATE

Given the high transactions costs and significant risks associated with such very early stage investments, managers of VESFs are experimenting with new models to improve fund economics. This includes but is not limited to innovation in operations through close upstream partnerships with pipeline builders as well as downstream partnerships with follow-on investors as well as process standardization at every stage of the investment cycle. Additionally, fund managers are exploring and diversifying instruments, with an increasing appetite in quasi-equity and self-liquidating instruments.

At the same time, existing and new market entrants are testing new fund structures. This includes permanent capital vehicles and evergreen structures as a shift from closed-ended VC funds with a 2&20 fee model. Investment vehicles are increasingly thought of as part of a conveyor belt across the capital spectrum rather than standalone actors/ For example, accelerators are setting up seed funds to bridge the gap to Series A investors and growth-stage investors are setting up early-stage vehicles to build their pipeline.

Yet because this type, or ‘class,’ of investment vehicle is early in its development, there are few validated best practices and fundraising for VESI vehicles continues to be constrained by the risk appetite and familiarity of potential investors.