It is not easy to start a VC fund. Even in favorable macroeconomic conditions many of the capital sources available to established VCs are not easily accessible for new managers.
VC funds are usually structured as limited partnerships between the General Partners, (GPs), who manage them and the Limited Partners, (LPs), who invest in them. First-time VC fund managers often have family offices, individuals (including exited entrepreneurs), corporations (often having strategic interests), funds (or government agencies) among their LP base. New VC managers are unlikely to be supported by foundations, pension funds, insurance companies or foundations. These institutions allocate capital to the VC asset classes but often require a history of successful investments. In some cases, they may also demand a minimum ticket size that is greater than the amount being targeted by new funds.
The industry has seen a shift in priorities and timeframes for fundraising following the COVID-19 epidemic. Due to the length and nature of the GP/LP partnership, LPs tend not to be quick in committing capital. This behavior has been only reinforced by current high levels of uncertainty.
“Fundraising in today’s environment is very difficult. Investors are tempted to reduce their most risky assets, i.e. VC. However, there are still a few first-time teams that manage to close smaller funds. This is because they have a different approach/strategy that makes more sense and responds directly to a market need with higher returns expected,” says David Dana Head of VC investments – Disruptive Tech & Innovation at the European Investment Fund ( EIF).
EIF’s returns analysis has shown that first-time funds make up a significant portion of the top 10 most-performing funds. data from Cambridge Associates in the US also shows that new funds are consistently ranked as the best performers. What are the contributing factors to this success? “First-time VC managers are eager to prove that they can be successful and make a difference. It is becoming more common for entrepreneurs to join hands with technical experts in order to create new funds. They are more aware of the challenges entrepreneurs face and want to share what they have learned from their own experiences for the benefit of other entrepreneurs. Dana says that fundraising is more difficult for established managers than it is for newer ones.
A strong reason to have your fund exists is crucial for any aspiring VC fund manager. Here’s a quick overview of the most important things to say if you are thinking of raising VC funds in the future. Although the seven areas are divided, they all have interconnections and should be merged to create a cohesive story and strategy.
1. Record of track
Prospective fund investors will naturally be interested in your track record and credibility. Spend time explaining your collective experience, diverse skill sets, and history of working together if you have a core team. Everyone has a story. The story should include at least some previous exposure to startups as well as an understanding of the venture industry.
Did you manage an accelerator? Talk about the process of selecting, supporting, and supporting entrepreneurs. The more detailed you can be, the better. We want to know the entire value chain, including how you met companies and your actual involvement in helping startups grow. We like to know what has worked and why. We then talk to entrepreneurs and get their opinions on investors. This is often the most important reference point,” says Catherine Dupere Partner at Isomer Capital.
Did you have a role as an entrepreneur? You can apply that experience and insight to invest in a new way. Dupere advises, “Don’t underestimate how important it is to connect on a deeper basis with entrepreneurs you wish to support.”
Conversations with LPs are easier when the aspiring GPs have direct investing experience. You’ll hear LPs often say, “We invest in first time funds but not first-time investors.” These could be business angels, or part of existing investment entities such as a syndicate of angels that invest together. Family office, VC or corporate venture arm. If you are part of an existing investment entity, you should be able to highlight your contribution and discuss how you will replicate that success without the support and infrastructure of that umbrella.
Even if your previous experience in direct investing is valuable, it’s not a quick exit so LPs may only have unrealized returns. Emerging fund managers can provide a positive signal by highlighting prominent investors in the later stages who are willing to support their portfolio companies. New fund managers can benefit from an understanding of the exit process, even though sophisticated investors are able to see beyond cash exits. How will your companies exit? And how can you help them? Dupere warns that this is a question not all early-stage investors think about. Consistency in performance is also an important consideration if the managers have experienced exits, and the timeframe under analysis is sufficiently long.
Be authentic and try to establish trusting relationships with your LPs. Trust and chemistry are very important. It’s a partnership, after all. Dupere explains that LPs need to maintain a close relationship with GPs in the same way founders do with them.
2. Vision, purpose and mission
Think about why you want to raise new funds (e.g. To support underrepresented founders, to support impact-driven startups, address an unmet market need; and change the way VC works. It’s a good idea to articulate the purpose, mission, and vision of your fund.
Own your difference. The founder’s passion for solving a problem is what makes some of the most successful startups. What problem do you want to solve? Why do we need another fund? In a crowded VC market, authentic motivation and an approach will help your fund stand out to both investors and entrepreneurs.
It’s a demanding job that requires you to be constantly challenged. Dana says that you must be motivated and able to justify the decisions you make. Understanding what you want to accomplish and why it is important will help you persevere when you face challenges.
3. Thesis on investment
A clearly defined investment thesis is essential for any new fund. This could include your macro-level view of future market opportunities, specific underlying technologies, and your investment approach. It is a good idea to let your track record and any insights that you have gained during the process inform this. The next step is to clearly articulate your vision in a way that empowers entrepreneurs to self-qualify. You should then be able to clearly communicate it to entrepreneurs, allowing them to self-qualify (i.e. You should always question your assumptions and reexamine them. Investment thesises are not permanent. They change with market changes and time.
The investment thesis answers the crucial question: What types of companies are you going to focus on? Consider the topics, business models, stages and geographies that you would like to target, as well as how you can do this. The frameworks and principles that will guide you in evaluating companies and the criteria behind investment decisions should be clearly articulated. Demonstrate that you have access to these types of startups or are able to obtain them.
4. Deal flow and sourcing
It is important to be exposed early enough to relevant startups. You can think of ways you can nurture and earn that. Managers of VC funds often talk about the channels they can use to keep a strong pipeline (e.g. Partnering with other investors to help them see potential opportunities before others (e.g. links with universities and research centres; having a private source of deals (e.g. by operating an incubator or accelerator; using technology to identify and/or choose startups (e.g. EQT’s Motherbrain, CapitalT’s VCVolt); creating a prominent and respected brand in market so startups can reach out proactively (e.g. Publishing valuable content.
5. Reputation, network, and edge
It is not guaranteed that great startups will be selected early enough to receive your funds back. I wrote more . This is where your reputation, network, and edge come in.
Are there any unique qualities about your approach and expertise that could attract the most successful entrepreneurs? Dupere advises, “You need to consider what you have that the market does not have.” This is why great founders are drawn to you.
Dana also agrees. “There have been a lot capital channeled towards early-stage VC Europe. It’s not about money, but the good entrepreneurs have the option. We (EIF) are not afraid to support new teams – on average, it’s 25% to 30% of our annual revenue. What we need is to be able to see their unique contribution compared to the rest of the market.
Beyond the edge, having a network of relevant people is important as it allows you to support entrepreneurs (e.g. Through introductions to potential co-investors and talent. A number of new VCs are explicitly leveraging communities and networks in their models (e.g. ByFoundersVC provides their portfolio companies with access to 50+ successful entrepreneurs from the Nordics and Baltics.
Your network’s depth and reputation positively impacts deal flow. Then, your ability to support startups and partner with them further will be impacted. “Venture can be described as a people-based business. Dupere emphasizes that you must play well with other people. It takes effort and time to become a part of any ecosystem. It is a good idea to start thinking about how you can help or contribute. You can make a difference in any way you want.
6. Model and terms of the fund
It is important to consider your capital allocation strategy as well as how you will approach portfolio construction. This includes the number of companies that you are targeting, ticket size/ownership in each, and follow-up strategies. You should also determine the minimum fund size that is viable.
Prepare to communicate your expectations regarding fund performance and the assumptions behind the model. Compare your expectations with industry benchmarks for similar funds, other types and other asset classes.
Be ready to justify the proposed fee structure, which is typically divided between management fees or carry. Consider special terms, such as. You might also consider co-investment rights and management fee breaks. You could offer early anchor LPs. In what circumstances would you be willing to do this?
Receive specialized advice about the legal setup that you will need to manage the funds, invest them, and disburse them. Consider the infrastructure and resources you will need to ensure compliance with all requirements.
7. Team commitment and GP/LP alignment
It is a long-term task to manage a VC fund. GPs must show dedication and align their interests with the LPs. First, commitment usually reflects the time that is available for the fund. The fund will be the primary focus of the core team. LPs expect a financial commitment by GPs at least 1% of fund size. This might prove difficult for young teams. How is this commitment compared to the private wealth of GPs?
“We don’t ask for bank statements. But the belief that 1% is enough is wrong. The average European average is about 3%, even for first-time teams. The team commitment is part of a package that allows strong alignment between GPs/LPs. Other terms like the management fee and cap, hurdle rate, and the cap are also considered. Dana shares that we carefully consider each case before asking for a percentage.