With Tokenization, the Time has come for Evergreen Funds
Evergreen fund structures for venture capital can offer many advantages over more traditional fixed-term structures. As these funds are open ended and have no termination date, they give fund managers more flexibility to take advantage of new opportunities with re-invested capital. At the same time, investors are not required to commit capital over 10-year time frames, giving them more freedom to re-allocate as their strategy changes. Despite their 20 plus year existence, evergreen funds still represent a small fraction of the total number of venture capital (VC) funds today.
However, tokenization through blockchain technology can enable even greater transparency and liquidity into the investment process, allowing evergreen funds to fulfill their promise of a more flexible, liquid investment vehicle for private markets - although liquidity cannot be assured.
As evergreen funds have no termination date and are not required to return capital after an exit, investors need a mechanism to withdraw their capital. In a traditional evergreen fund, the fund manager enables redemption events which can be scheduled or triggered by portfolio exits. This is not a perfect solution, however, as it does not provide true flexibility as with open end funds in other asset classes. Liquidity events may not line up with investors’ preferences and could still result in forced portfolio exits.
A liquid secondary market can provide a better solution by enabling investors to sell their interests to other participants. Until now, the opaque nature of venture capital and complex regulations around secondary trading have stymied trading in VC funds. Tokenization using blockchain technology addresses both of these problems: a digital ledger enhances transparency while smart contracts can programmatically enforce compliance regulations resulting in streamlined liquidity provision. In this way, exit liquidity is provided by the market, and not by the General Partner (GP). This allows the GP to focus on managing the fund’s portfolio investments without worrying about having to exit by a certain time (which may not be the most opportune), and without the continued distraction of always raising for the next fixed term fund
We are now beginning to see the emergence of evergreen VC funds that issue tokens representing limited partner (LP) interests in the funds. These tokens can trade on a handful of Alternative Trading Systems (ATSs), specifically designed to handle trading of blockchain-based digital security tokens. With continued growth in the overall digital securities ecosystem, we will also see underlying portfolio private company investments become tokenized and increased trading on digital securities ATSs; meaning that the portfolio manager will be able to quickly re-deploy capital across existing portfolio holdings or more easily handle on-demand redemptions.
A more liquid VC fund structure can also open up the opportunity for new segments of investors. Whereas typical venture capital funds rely on LPs who have long term capital such as pensions, endowments and family offices, a tokenized evergreen fund could attract more high net worth investors, macro investors and fund-of-funds who may wish to invest for shorter time periods or rebalance their asset allocation more frequently. In addition, evergreen funds do not require capital calls, meaning no unexpected capital requirements and allowing investors to deploy capital at their own discretion.
It is still early, but with investors increasingly looking for more efficient access to private markets, tokenized evergreen funds will have an important role to play in the future of the venture capital industry.
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Investors should also consider the risks associated with digital securities and private investment opportunities. Blockchain is a new technology and unproven in financial markets. There is no guarantee that tokenization will enable any secondary market liquidity in the future and your investment may remain illiquid. Private securities offerings are not registered with the SEC and are considered highly speculative. An investment in private securities may result in the loss of your entire capital contribution. We recommend you consult an investment advisor before investing.
Richard Johnson
CEO, Texture Capital
Ciarán Hynes
Managing Partner, Cosimo Ventures