You have the vision to become the next mover and shaker in venture capital – now for the not-so-insignificant task of making it a reality. You’re fully equipped with a proven track record of successful investments in a venture capitalist environment and have devised a business model that convinces others with money to share your vision.

So now you simply identify the next tech unicorn, see a 1000x return, and rinse and repeat. Sounds easy, right?

It’s a lovely thought, but the reality is far more complicated. No VC worth their salt builds a strategy around the very low chance of assuming they’ll invest in an undervalued business that’s staged to revolutionize the world. Ask any micro-VC manager about how hard they have to hustle and you’ll get a sense of just how much work launching a fund is.

Not too long ago we looked at the journey of Elizbeth Yin, a General Partner of the very aptly named Hustle Fund, that exemplifies both that entrepreneurial enthusiasm and the realities of running a micro-VC. She pulls no punches on the difficulties in the early stages of running a micro-VC – including the fact that you’ll be bootstrapping for 5-10 years, and likely not make a lot of money on your first fund. A micro fund owner needs to have a 20 to 30-year mindset. Not to mention her days are crammed juggling all the multiple hats she wears.

She breaks down her weekly priorities such:

  • 50% fundraising-related (preparation of materials, meeting potential future investors, networking, etc.)

  • 20% marketing-related (content, speaking, etc.)

  • 5% ops (legal, audit, accounting, deal docs, etc.)

  • 15% looking at deals (talking with co-investors and referrers, emailing with founders, looking at decks, talking with founders)

  • 10% working with portfolio companies

You can’t wear kid gloves when you’re looking to launch a VC fund – you need to go into this endeavor fully prepared and with a boatload of confidence.

The journey is not a straightforward one either. There are hundreds of venture capital firms out there, so how is YOUR firm going to stand out? Here are some of the questions you need to answer to get all of your ducks in a row and narrow down investment targets:

1. Who will you choose to be your partner?

2. How will you go about raising capital for your fund?

3. What industries will your VC fund focus on?

4. At what stage of a startup’s lifecycle will you choose to invest?

5. How will you structure your fund from both a legal and accounting standpoint?

6. What types of skills do you need on your fund’s management team?

In this post, we’ll explore some of these considerations to help get the wheels turning for each of the pieces required to get your fund off the ground.

Planning Out a Strategy For Your New Venture Capital Fund

Define Your Investing Strategy

The venture capital industry is a small and crowded space. To sell potential LPs and startup founders that you’re the right fund to work with, you need to stand out in your philosophy and focus. Even still you can expect to have to go through hundreds of meetings and calls with potential LPs from larger venture capital funds, pension funds, family offices, high net-worth individuals, and corporations before you can successfully raise your fund.

Rajat Bhageria and Nandeet Mehta founded their first venture fund, Prototype Capital, in 2018 when they were 19 and 21, and with very little capital. They knew they needed a way to differentiate themselves from other VCs in the space:

“We noticed the software industry is becoming saturated and noisy and prophesied that traditional industries like healthcare, transportation, consumer packaged goods, and manufacturing are where massive transformation will happen in the next fifty years. In these industries, the potential founders who have domain-level expertise are distributed all over the country, not only where the lion’s share of VCs invests, San Francisco. And thus our “unfair advantage” was our scout network who would be able to find founders around the country that other VCs aren’t even paying attention to.”

To thrive in this space, you’ll need to find your niche and develop a strategy that will entice investors. Factors to consider include the types of industry you want to invest in, their lifecycle stage, and developing a scalable system to get new businesses in your pipeline.

Define Your Compensation Structure

There is a very large fee drag when starting a VC fund. In general, you can assume to only be able to pay yourself a salary of 2-3% of the fund, which doesn’t amount to a lot. Your first fund should largely be about building a name for yourself, so you shouldn’t expect to get rich.

VC Stefano Bernardi Explained the financial compensation structure for his small angel fund Mission and Market back in 2015 – and this is assuming a relatively high return of 3x:

“In our case, we’re aiming to make 60 investments out of our first fund. That means investing $1.5M in first checks, and then keeping what’s left (~ $1M) for follow on investments.

By doing this on a $2.5M fund, you are deciding to use the $50k a year in fees to make more investments and have a higher chance to provide solid returns to your investors. Incentives are also much more aligned.

If we had taken out the fees, over 10 years we could have drown $500k. That’s insane. It’s one-fifth of the full fund gone. So now, you need to return a multiple of a $2.5M fund, but with only $2M to invest.

Our compensation is fully based on carrying, and only kicks in after we’ve returned the full amount invested first. After that, we start sharing 20% of the returns. If we double our investors’ money, then we receive 30% of the following profits.

Say we return 3x our fund, $7.5M. That translates to $2.5M * 20% + $2.5M * 30% = $1.25M. Divided by 3 people that’s $400k, and divided by 10 years, that’s 40k/year. We could all get $40k more a year just by switching jobs.”

You need to have a true passion for this industry to get off the ground and work through the lean years.

Define a Due Diligence Process

Auditing businesses you’re looking to invest in is a time-consuming process, but due diligence is a necessary part of running a VC fund. You’ll need to establish your baseline for what you’re looking for in a startup, which will depend on the life stage of that startup. Some of the factors to look at include:

  • Strong Financials: Does the company already exhibit strong YoY growth and steady cash flow? How confident are they (and you) in their business projections?

  • Market Considerations: How in-demand are the company’s products or services? How big is the market size? And how large are both projected to be in the short and long-term future?

  • Company Culture: Does the company have a well-defined vision and mission and employees at all levels who are committed to seeing it develop?

  • Competitive Advantage: Does the company’s business model offer a significant competitive edge over others in the same sector?

Due diligence can be a time-consuming process, so you should have a standard operating procedure in place for running these audits.

The Nitty Gritty of Forming Your Fund and Backend Operations

There are plenty of operational considerations for emerging managers to consider, particularly related to the fund itself, a firm’s operational considerations, and the selection of appropriate service providers who will ultimately execute ongoing functions

While emerging managers of new fund launches are initially consumed with fundraising, careful consideration of basic checklist items can pay important dividends for years to come.

Be sure to read BDO’s guide on the nitty-gritty of structuring a new fund for advice on:

  • Limited Partnership Agreement Review

  • Valuation Considerations

  • Cybersecurity & Data Protection

  • Compliance and Regulatory

As for the selection of backend personnel for accounting and administrative, it’s important to choose a provider with extensive experience in the Venture Capital space.

Consult With Your Friendly Neighborhood Venture Capital Consultants

Think that a VC consultancy is what your firm needs to find success? Running a fund is also running a company with payroll, accounting, and HR. Rather than have to split your time from sourcing deals and managing limited partners, bring on a consultant that knows the industry inside and out.

At GCG, we’re in the business of helping investment funds succeed through strategic financial and back-end management. We help our VC clients overcome their unique challenges in ways other outsourced financial and accounting firms do not. More than 200 Venture Capital and Top Private Equity Firms have found that our back-end financial and administrative services save them time and money by providing the high-level executive insight they demand but don’t need as a full-time employee.

If you’re looking for support in managing the finances or processes at your venture capital, reach out to our VC consulting services specialists and we’ll get right back to you.