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Sidecar funds, corporate vehicles, club deals: how do startup studios get financed?

Quentin Nickmans
Quentin Nickmans is a founder at Hexa. An expert in SaaS business strategy, Quentin has helped launch over 30 companies. He is passionate about supporting talented founders and shaping young startups into companies, with Hexa or as a Business Angel.

As explained in The Rise of Startup Studios, a white paper published by The Global Startup Studio Network in 2019, the term “startup studio” covers a wide range of actors and operating principles.

To be considered a startup studio, we set an arbitrary threshold of a minimum of 6 months of highly active assistance to each startup. Anything below the threshold can be broadly covered by the term “accelerator”.

A variety of models

The 2 core differentiation criteria between different types of startup studios are:

Are the ideas born “internally” and subsequently pitched to entrepreneurs who’ll join the venture or does the studio consider “external” ideas by partnering with or finding inspiration from an existing team of entrepreneurs with their own idea.

Are the created ventures “independent by default” from the studio or are the ventures dependent of the studio’s operational resources, aka the “integrated model”.
If we can create a matrix mapping out these fields, we can plot most studios along these two criteria:

It should be stated that there is no value judgement in this matrix and each quadrant holds its lot of highly successful studios. While it might be relevant for an eCommerce-focused studio to share a lot of resources and adopt the integrated model, on the other hand studios with a high need for creativity — typically software development — will tend to lean naturally towards creating independent ventures in order to provide maximum freedom to each cofounder on their road to success, as is the case for us at eFounders.

Ownership and number of ventures

Although these 4 types of studios differ from one another, the ownership they possess in their startups seems to highlight a trend:

The closer a studio is to an integrated model — the higher the ownership in the startups.

The more the studio focuses on external ideas, the higher the number the ventures they work with.

Now let’s bridge the gap between these different types of studios and their financial models. In principle, there are 2 ways to finance a studio:

First, investing in the corporate entity that is the studio. The studio raises money to finance all operations, running the studio and their projects. The equity owned in each venture belongs to the corporate entity.

Second, creating a sidecar fund alongside the corporate entity. In this model, funds are raised via LPs and will be used to finance the studio (for a small amount) and finance the projects built by the studio. The equity owned by the studio represents the ideation or sweat equity and the sidecar fund also owns (a significant) part in each venture as their first financial backer.

It’s logical that an investor should join the corporate entity capital of Platform Builders and Execution engines since these studios have a very high ownership of each venture they build and the ventures are highly dependent on the studio over the whole life-cycle. Conversely, Service Experts should setup a sidecar fund. Their combination of low ownership and high number of projects bring them closer to traditional VC economics, where they will deploy significant funds in their most successful independent projects. For the Crazy Creatives, the situation might be more complicated and therefore a third, hybrid financing strategy exists.

Option 1: Attracting investors in a corporate vehicle

For startup studios, fundraising is difficult. Especially at inception: a strong track record is required to convince investors to back your studio strategy. You also won’t have the funds to complete follow-on investments on your portfolio companies’ subsequent funding rounds and you’ll end up losing important voting power and leaving carried interest gains on the table.

But since you invest your own money, you get more flexibility on your operations. There are no conflicts of interest with your investors. You invest on an evergreen basis and are on a more entrepreneurial path, with long-term commitment alongside your companies.

Option 2: Setting up a sidecar fund

Putting regulatory issues aside, raising a fund is simpler. Your investment thesis is known. You have cash to invest on ‘ideas’ and on successive financing rounds of your most promising portfolio companies, preventing dilution of your voting rights. You have management fees to finance your operations and you need to set strong rules and safeguards to prevent conflicts of interest such as: who decides if an idea needs to be financed by the SideCar fund? Who decides if the Fund needs to invest its pro-rata in successive rounds?

This fixed set of rules will reduce your flexibility in your operations. You’ll need to comply with a lot of regulatory constraints and, ultimately — as a studio founder — you’ll only enjoy financial return based on the carried interest of the money your LPs invested in the Fund.

Option 3: Club Deals

At eFounders, we started working to create our own sidecar fund back in 2016. But, facing the risk of conflicts of interest (the shareholder structure of a sidecar fund and the studio will always differ), and due to the need to setup the restrictive rules required to prevent them, we ultimately changed our strategy. We remained with the corporate entity model for more flexibility, preferring small equity raises until our first exits to cover all our operational costs.

The downside, however, was that we were still leaving voting power and money on carried interest on the table by not being able to follow-on our investments at later rounds. So we decided to delegate our prorata rights to an investment club we set up ourselves: the eClub. We offer our community of HNWI the opportunity to take our pro-rata in each project on a deal-by-deal basis. We syndicate each commitment in a dedicated SPV represented by a partner from eFounders. Consequently, not only do we maintain governance at later stages in our companies, we also monetize our pro-rata via carried interest.

The obvious objection to this is that running a club with 100+ investors is very time consuming. Sharing investment opportunities, matching investor profiles, collecting commitments, processing the administrative part for the deal closing, and following up with regular reports to be sent out to the investor community might look like a time consuming effort. Being a startup studio focused on B2B SaaS, we naturally turned to software to streamline the process and make it scalable — only to realise that there aren’t any solutions available on the market that fit our needs.

Pursuing our strategy to grow our eClub without an adequate tool would have required time and effort which we are short given that most of our resources are dedicated to our projects. So we decided to create Zenvest, a dedicated club deal management software designed specifically to meet our needs. Via this platform, we were able to run our investment club with 100+ members and raise upwards of than $25M with a third of an FTE required to run the Club. We managed to do this within the first year since deciding to explore the potential of club deals. We’ve opened the platform to be used on a SaaS model by other venture builders looking to broaden their financing options, and we’re happy to chat with you if you feel like Zenvest might be useful to your financing strategy.

A club deal strategy bridges the best of both worlds and is an attractive alternative to consider

Ultimately, our advice to those of you who may be considering this hybrid financing strategy is that club deals are a great way to sidestep the downside of corporate vehicles and sidecar funds:

If you are looking for small, progressive and not too dilutive funding options: club deals allow you to finance the corporate entity to cover operational costs and leave funding for follow-on investments to club deals.

If you want to adapt funding amount and ownership structure to each opportunity: club deals enable you to prevent conflicts of interest by offering deals directly to LPs as well as avoid committing to certain rules that don’t adapt to every opportunity in your portfolio.

For us, turning to club deals and building out our eClub to support that strategy was worth it. It allowed us to avoid leaving voting rights and carried interests on the table, while also staying flexible and adjusting our model to account for the specific needs of each company we build. It isn’t the simplest choice, and it doesn’t work for all startup studios. But for studios in the Crazy Creative quadrant of which we are a part, we thoroughly recommend it.