Venture capital is a form of private equity and a high-risk & high-profit type of financing. Simply put, a general partner (GP) acts as a VC founder that balances making good returns for limited partners (LP), who are fund sponsors, and covers operational costs to earn a reputation as an astute investor and productive manager.
Since venture investing is gaining more and more interest from well-off investors, we couldn't possibly leave the world without our guide — how, in fact, can anyone set up a venture capital firm?
Here's a little Q&A on how much money, time, and nerves it takes to run a VC. And also some seasoned advice on what steps to take to start thriving.
Before launching a VC, let's agree on the terms. Venture capitalists focus on super-young budding companies — 92% of which do not survive, shows a report from Startup Genome. The odds of becoming a unicorn like Canva, Epic Games, and Telegram are as slim as 1% according to CB Insights — and this fact is hard to refute.
But if you join the exact project before it's at a hypersonic speed, that spaceship will tow up all the others. A true fairy tale of all VCs is to find so-called disruptors — teams that can blow up the market the way Discord or Stripe did and who can squeeze the S&P 500 inhabitants.
Сhasing the stars can take time: on average, a VC firm's lifecycle is ten years. In this period, the medium target rate of return worth sticking with is 30% at the seed stage and 20% at later stages. This benchmark was derived from Industry Ventures analysts. They also confirmed the golden rule of "1/3, 1/3, 1/3," which states that usually, one-third of investments fail, another one-third generates a typical return, and the remaining one-third turns into a cornucopia.
Likely, the most popular question about starting a VC is how full should the pockets be. An answer is "people invest in first-time funds but not in first-time investors," meaning that angel experience and personal branding are far more salient than money.
However, investing your own savings is still very desirable — proving you are in the game. General partners are expected to contribute around 1-5% of the total fund. In Europe, the average input is about 3%, says David Dana, head of VC investments at the European Investment Fund.
Because venture capital funds range from a few to hundreds of millions of dollars and typically possess $10-15 mln, that 3% cannot be called a small stash. Even the 1% of a fund capital commitment makes it hard to raise funds, the GP of Ganas Ventures Lolita Taub laments. "Consider that for a $20M fund, a 2% commitment with 2 GPs is still a $200K commitment for each partner. This is out of reach for many of us," she said on Twitter.
There are options, in any case. For example, Cendana Capital founder Michael Kim recommends considering commission-based compensation: not tapping into personal savings and instead gradually deducting the required sum from the management fee. Or another way: use portfolio companies as collateral.
Kim cites as an example at least two high-profile managers who created the venture fund by bringing on the table stakes in startups they participated as angel investors. Options like bank loans are quite ubiquitous — but be careful — such dependence might lead to selling a well-performing position too soon.
The founder of Fort Ross Ventures advises following the "15% rule": before running a VC, evaluate your liquid capital minus usual living expenses and invest 15% of the remaining amount. In doing so, your expected return should be at least 15% per annum — less return on the same investment can be obtained with less risky instruments.
Venture capitalists are also startups: the main thing is to find a gap in the market, design a promising strategy, and attract investment and perfect partners during early stages. After that, the rest is up to the lawyers and service providers.
But first things first. To lasso a unicorn, follow this 5-step process:
What stage, industry, and location are you going to focus on — Scandinavian's femtech at the seed stage or all of Europe's growing fintechs? Usually, GP only outlines desired startup areas and stages.
But, as the Silicon Valley editor of TechCrunch, Connie Loizos, points out, here is a new trend for narrow-niche VCs, "A venture firm focused solely dedicated to oral care and not something, um, a little broader? A firm that’s focused on tech that can help detect and contain wildfires? How about a venture firm that’s dedicated to backing and building psychedelic businesses alone?."
Go further. What sets you apart from other funds, and why will you be the one to bring income — is it unique contacts or profound experience? How will you make investment decisions — give the same amount to hundreds of startups at once or accompany a dozen selected ones on every round?
Your pitch deck should answer all these questions, be clear and selling. Collect feedback carefully, along with building VC and raising capital — and keep polishing your message. Your potential LPs will want to see how you’re differentiating from others.
VC firms need the basic infrastructure before raising capital and meeting with potential portfolio companies. The process typically starts with the registration of a limited partnership and the creation of a management company.
Suppose you are in no rush and have deep pockets. In that case, you can hire lawyers and several service providers to draft the limited partnership agreement (LPA), get your management company compliant with the regulations, and set up fund administration procedures among other things. Should the time and cost matter — reach out to Uniborn; we are here to help you launch and run smoothly and efficiently.
Reach out to those who believe in your vision and you personally. Make sure that your resources complement each other: if you gained a strong personal brand, look for a larger audience; if you possess a narrowly unique expertise, look for someone who can predict broad market trends; and so on.
When considering the initial amount, it’s best to treat your first fund to prove concept validity rather than pursue big numbers. This is what the well-established investors shared during the VC Lab discussion.
As a first-time fund manager, you will spend most of your time and energy raising capital for the fund. But it will only make sense if the back office is organized. As BDO warns, , "In the fervor of fundraising, many emerging managers may lose sight of the fact they are actually running a business with employees, payroll and overhead expenses."
Even if you’re starting as a solo GP without any employees and partners, as you raise a subsequent funds the complexity of your operations and your team’s headcount will only grow. Large VC firms have to spend millions of dollars each year on fixing inefficiencies that wouldn’t exist if the foundation had been properly built from the start.
So make sure to take care of legal and accounting support, human resource framework, IT platforms for communication and reporting, and data security to avoid future roadblocks. For instance, the fund wouldn’t grow without a coherent and consistent internal promotion policy and compensation allocation plan. "A comprehensive write-up governing human resource-related decisions would address any future issues," BDO experts suggest.
The fund's team should take care of deal flow — the selection of potential projects, and due diligence — an in-depth analysis of nominees.
Having access to exclusive investment opportunities that many do not have is often something first-time managers take for granted. But to extend this further, follow Pitchbook, Crunchbase, and investors' social media. For example, here is a list of European business angels on Twitter.
As for the detailed due diligence, it should cover management, market, product, legal — and of course, traction and financials. Here is a kit of documents for venture due diligence made by 4Degrees founder Ablorde Ashigbi, from financial statements and projections to active contracts and competitive analysis.
While investors may hesitate about launching a VC after a stormy 2022, the recent CB Insights report indicates room for some optimism. While global funding is down from a record-breaking 2021, it's still higher than in 2018, 2019, and 2020.
From January to June 2022, investors allocated $250 billion to startups worldwide. That's -12% over the same period in 2021 but +108% over 2020, +85% over 2019, and +77% over 2018. The USA (35%), Asia (34%), and Europe (22%) accounted for the largest share of investment. In addition, Europe saw a minor decline among the leading regions.
Moreover, novice fund managers outperform their experienced colleagues, Preqin data proves. Cambridge Associates adds that new and emerging venture funds are consistently among the most successful in the industry.
Cover image: Unsplash
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