One does not simply raise a venture fund. Perhaps you are or would be a fantastic investor. Perhaps you have a deep understanding of a realm of science or business. Perhaps you have been a fantastic entrepreneur yourself. Perhaps you know many people who are capable of building great businesses and know that they would happily work with you, take money from you, and make money for you and your investors. None of those things matter. You see, in order to be a venture capitalist, you have to be a venture capitalist. Venture Capital is kind of like a guild. You have to be invited.
A venture capitalist is somebody who has been invited to become a venture capitalist by an existing Venture Fund, or has raised their own fund from one or more limited partners, or “LPs”. Venture Capital founders or partners call themselves General Partners, or GPs. Venture Capitalists manage, or invest, this capital, generally in startups. In the finance world, this is known as an "alternative" investment. Since everybody knows that by default you should invest in stocks and bonds and maximize your wealth manager's fees. Private Equity is also considered an alternative, and to this day nobody has been able to explain to me the difference between a Venture Fund and a Private Equity fund, though they all assure me they are quite different.
Venture Capital is not very complicated. A “fund” is just a company, a legal entity and bank account that other people wire money to. There are three bank accounts total, an account for the LP capital, another for the manager's equity or GP, and one for the management company, which pays salaries and most expenses. The fund manager manages this money, usually by buying stock, or contracts that convert in to stock, in small businesses, which hopefully become bigger businesses and may eventually get acquired, or IPO or, sell that same stock to somebody that is willing to pay more, thus growing the value of the portfolio. There are many ways to “exit”. Whether they ever return equity or not, the LP account pays the management company a fee, usually 2% average but most funds start higher at the outset and lower over time. The GP typically takes 20% of the equity returns, or the "carry", short for carried interest. Investors in the fund sign an LPA (limited partner agreement) and a Subscription Agreement, both of which are unnecessarily complicated and lawyers make too much money on upstart funds. This is called "2 and 20", a very standard structure.
A well managed fund can be expected to return 4 times the capital invested over 10 years, though some breakout funds have done much more, up to 20x invested capital. However, some funds never return a dime. Also, unlike public market investments, the stock is not liquid, so the LP must expect their money to be "tied up" for potentially a long time. Despite perceived uncertainty, there are plenty of funds that reliably return impressive amounts of capital and relatively few end up returning none. Cambridge Associates has good data on fund performance across different categories and years. Though again LPs tend to just invest in people they like and trust. Some funds from known trusted investors can close in a couple of weeks but that is rare. Recently a friend of mine who is a known VC with a fantastic track record went out to raise a fund. It took 380 calls.
Is this the only way to manage capital or support innovation? Of course not! Experiment! Fund managers are founders too. Find a new way to do things. Be an innovative fund manager. It may make sense to do things the default way the first time but clearly this standard model is not optimal. I would love to see more R&D investment, more holding companies, more revenue sharing deals, new standardized deals, more founder friendly terms, crossover funds, evergreen funds, invention labs, licensing deals, and funds focused on people and technology Silicon Valley forgot. There is a ton of opportunity for innovation in Venture Capital. Carried interest has changed little since its appearance in the 14th century merchant guilds. Maybe it is time we came up with a new structure.
While the founder is the spark, the world depends on venture capital to be the gasoline of the engine of capitalism and economic growth. Most growth, most innovation, most interesting ideas come from small businesses. And small businesses need capital. Not a lot, if you do it right, but somebody has to develop the expertise to analyze which ones are the most important and viable and the resolve to focus on them until they are brought to fruition, a long and at times stressful process. I do not think there are too many VCs. I think there are not enough VCs!
A venture capitalist is a completely different species than a wealth manager. Yes they both use other people’s money to do business, yes the compensation structures may look somewhat similar, but their skills and ways of working are completely different.
A wealth manager is tasked with preserving capital. Do they want it to grow? Maybe, but that is not the mission. The mission is to protect it. What is the mission of the Venture Capitalist? Well that is the problem. Nobody has a clear idea of what a VC is supposed to do. Nobody has a clear picture of how to measure VCs against each other. Nobody knows what to optimize for.
Yes there are financial metrics like “IRR” and “TVPI” and “Cash on Cash”, but VCs and LPs never talk about those. They talk about who they like, who they have known for a long time, who they think is interesting. Some VCs are optimizing for their social media some are optimizing for their personal bank accounts some are optimizing for the size of their fund some are optimizing for the size of their team some are optimizing for their lifestyle some are optimizing for their families some are optimizing for their founders some are optimizing for their reputations some are optimizing for their valuations some are optimizing for communicating with their LPs some are optimizing for their exits some are shifting what they are optimizing for all the time. I have met managers who want a $100m fund like it is some kind of trophy. They have no vision for innovation. They just want the badge.
This is the problem. There is not enough of an implicit mandate or strategy for a VC. They are all doing different things. You would be shocked at the number of “blue chip” VC partners that do not have a clear answer at all when asked what they are focused on. They hang around in clubhouses, see what comes to them, and write checks when they feel like it. They are looking into crystal balls and reading tea leaves and seeing who their old buddies introduce them to and throwing money into the wind! There is no focus. There is no discipline. They build nothing.
The fix is to break open the definition of VC and LP. I’m a VC, I’m an LP and you can be too. In fact you should start thinking like one. Right now. You do not have to be a pension fund or endowment to invest in a manager, especially an emerging manager. Emerging managers have such a difficult time raising funds (LPs have practically unionized against them, even though first funds usually have the best returns in a managers career!) they would probably take your money on any terms whatsoever. In fact, I don't think anyone should take money from a pension fund at all. I think pension funds are a cancer sucking up all the money and oppressing innovation.
You don’t need big expensive law firms and flashy offices to be a fund manager. In fact those would be bad decisions for an emerging manager to make. You just need the spirit of innovation, helpfulness, and endurance. You must be trustworthy and constant. You do not have to make decisions quickly but you must stick to them. And you must communicate.
Pick a strategy. Be very precise. Be very focused. Identify your “circle of competence”. This is an area you know better than most people. It might be seed stage synthetic biology startups. It might be late stage enterprise software startups. It might be commercializing technology that was incubated at a research university. It might be -gasp- research itself! Or even policy or non profit work! Maybe you don’t need exits at all to do what you and your LP want to do in the world. Some funds never get an exit anyways!
You see, you can do whatever you want. You just need somebody to believe in you. Most LPs have tons of money already. You are selling ice to eskimos. Do you think they will get excited to maybe turn $1m into $4m in 10 years? Probably not, they are probably interested in inventions or people or impact or education or policy or dinner party conversations or writing.
The best way to support what your LP wants to support may not be a SAFE Note. That was a very recent invention. And it is not the only way to invest. Even before the SAFE, the Convertible Note had not been around very long. I know some of the people that started using this deal. They totally made it up as a hack to avoid legal and tax complexity. And it worked! Before long everybody was doing it because it was a new and better way to invest. This should happen more often.
Try it, come up with a new deal structure. Find a way to invest in science find a way to invest in carbon capture find a way to invest in beverages find a way to invest in open source software find a way to invest in open source hardware. Find a way to invest in people that VCs are overlooking. That is not hard. Whatever you do don’t do what everybody else is doing. That is not the way to innovate. That is the way to fail.
At first it may seem like all the LPs want a certain thing. They want a $100m third time fund investing in series A enterprise software companies. No, not all of them. You are not talking to the right people. Anyone can be an LP. Yes it is difficult to find the right partner. There are people working on ways to make this process better. But what you need to focus on is not getting lots of people to invest in you. It is to get the right people to invest in you.
Figure out what you are best at. Find somebody who will benefit from what you do. It may not even be a family office or “high net worth individual” or pension fund or fund of funds or hedge fund or fund of funds of funds of funds. It may be a company or a country or a prince or a friend or a farmer or a founder. It could be your own company! Running a company and investing on the side in things that benefit your company and the world is a great way to invest. It is not a distraction. You do not need some fancy structure or outside manager or call yourselves “Corporate Venture Capital”, just start investing.
If someone wants to invest in your fund but wants you to raise a bunch of other money from a bunch of other people before they do then just walk away. They are not being honest with you. They do not believe in you. Keep searching. Do not take a “qualified yes” do not make people sign “letters of interest”. Either they send the money or they don’t. You can’t make them. If they’re not ready just move on. Come back later. Get them what they ask for. It can take years. Be patient. Many incredible managers took several years to get their first fund off the ground.
You do not want to herd cats, especially cats as busy and flaky as LPs. Find one good partner. Understand their needs. Get the money in the bank. And be patient. Investing is not like being a founder. Things do not happen every day. They take a long time. Do not rush things. Adopt the pace of nature. Innovation is a natural process.
Many new VCs put the cart before the horse. They come up with a strategy they think is cool and then go out and try to raise the fund. Hopefully their strategy happens to match with what some LPs want. That is backwards. And it is inefficient. You will do hundreds and hundreds of calls and meetings, most of which go nowhere. Sure you may end up with a fund but there is a more efficient way. What they should do is find an LP first. Start with just one you like and respect and could see yourself being a long term partner with. Then work on a strategy together with them. Many successful managers spend their whole lives with only one or a very small set of LPs. That may happen. In fact simpler is usually better. If you do not know any LPs, do not try to raise a fund. However, it is entirely possible to get someone who does not think of themselves as a professional LP to partner with you. One good potential deal for an emerging manager is to sell part of the GP, say 10% for $500k, which I just made up. I do not recommend selling part of the management company. This guarantees a salary while you are raising your fund, and you may even be able to avoid charging management fees, which will make it easier to raise money for the fund. Once you have managed a fund, it gets easier to raise another one, though it is still not easy.
And then please focus. You cannot do everything. You cannot be all things to all people. You cannot do impact and moonshots and enterprise. You cannot be agnostic about anything. You must focus on a stage of company. You must focus on an area of technology. You must keep your companies and founders focused on innovation. Stick to your strategy.
Ethics is a very important topic that I do not think enough managers take seriously. Innovation without ethics can become very evil very quickly. I think every LP should have very serious talks with their managers about their ethical positions and their reasoning behind them. You don't have to agree on everything. Just make sure they have thought everything through.
Please do not not ghost. Please write honest and insightful pass notes about why you decided not to or are unable to invest. It's not hard. It does not take a lot of time. After you invest, do not quickly lose interest. Do not give up and move on at the first sign of trouble. Every great business has had multiple instances where they thought it was over but they persisted. You can tell a good investor by how much attention and love they give to their companies that are not doing well.
The biggest frustration I have with VCs is when they forget about the founder. Founder's Fund was a very innovative fund in that they were one of the first to see investing as backing a founder instead of getting a piece of a company. Obviously this is a winning strategy with regards to both financial performance and reputation, but funds to this day rarely choose or successfully execute on this strategy. Every institution and company is the long shadow of one person, usually its founder. If that person leaves or becomes marginalized the company will suffer. Many VCs have big bank accounts and famous friends and business experience and they think they may know more about a founder's business than the founder themself. They may join the board and see their relationship as a hierarchy when it should be a partnership. In theory, a founder's insight and sacred fire combined with the resources and experience of a VC should be an unstoppable combination. In practice, it often devolves in to an empty or even toxic hierarchy with the VC sending the founder chasing distracting ideas and strategies, or ousting the founder and their ideas entirely. The "we'll take it from here" board is a recipe for disaster. The board should be a multi-tool at the disposal of the founder, not their mercurial boss. Do not do this. Invest in a person and support them. Do not attempt to control them or marginalize them. Do not forget who put you on the board in the first place.
You cannot pull unicorns out of the sky. You cannot pull bread out of the ground. You must first develop your own skills and toolset and have your own teachers. Then you must lay a fertile bed of soil. Only then do you plant seeds and patiently watch them grow. The harvest will come. Some crops will fail some will evolve some will do better than you ever imagined. Learn to look at the sprouts and half-built houses and see the beauty in them. Don't just be patient, learn to love the long, slow process.
Please remember you are investing in people not slide decks. Be kind. Be constant. Be creative. And start early. Just start investing. See if somebody will take a small check. They probably will. Get experience. You will make mistakes. That is ok. Just do it and then do it better. Make an investment. It's fun!
Many people speak ill of VCs. Most are just jealous. All management involves others thinking they can do things better than you. Do not listen to them. They do not know your inner heart and you do not know theirs. Do not do it to be popular. Do it because you love it. Innovation, after all, is an act of love.