How To Raise A Venture Capital Fund: The Essential Guide on Fundraising and Understanding Limited Partners

By Winter Mead

Despite all of the writing on venture capital, there is a missing part of the literature. There has been no book written about raising a venture capital fund. It remains a secret to a few privileged venture capitalists who have gone through this fundraising process. Until now . . .

This book serves as a guide. It dives into the

• Language: English
• Publisher: Winter Mead
• Release date: Jan 1, 2021
• ISBN: 9781736234327

Book preview

Foreword

Despite all of the writing on venture capital, there is a missing part of the literature. There has been no book written about raising a venture capital fund. It remains a secret to a few privileged venture capitalists who have gone through this fundraising process. Until now . . .

This book serves as a guidebook to raising a venture capital fund. It dives into the process of raising a venture capital fund, the how-tos, the unique language of the limited partner (LP) world, secrets of how LPs think about fund diligence and alignment, the best practices in fundraising, what works, and how you can best prepare for success.

I’ve written this book after spending a decade investing into venture capital funds at a $30B wealth management firm and a $160B technology company. I’ve been on both sides of the table, the VC and the LP side. I’ve been behind the scenes managing every aspect of the fundraising process, investing into 80 funds, and reviewing thousands of fund investments. I also co-founded a company that specifically focuses on co-building venture capital businesses, which includes helping VCs understand the intricate dynamics of raising a venture capital fund. After reading my book, you will gain the knowledge and insights gained from these experiences.

Why I Am Writing This Book

In the current economic wave, innovation and technology have begun to affect all industries and geographies in significant ways. Innovation is a global phenomenon, and venture capital has become known as a form of financing that enables innovation. People associate venture capital with the future of innovation and technology, and in some cases, with how society will ultimately function.

Companies funded by venture capital have become the most valuable companies in the world. In fact, Apple and Amazon both started as VC-backed businesses and became the first publicly listed companies to reach one trillion in valuation (a thousand billions!). These two businesses began because venture capitalists invested in visionary founders who were talented at business building.

Recently, the market has become increasingly large, fragmented, and obscure. My goal is to clarify the process of raising a venture capital fund. Knowing how to raise a venture capital fund is an essential step in enabling more innovation. My goal is to encourage and motivate future generations of venture capitalists to raise venture capital funds. My hope is that more venture capitalists will enable accelerated innovation, resulting in large, positive impacts on a global scale.

The nomenclature of a venture capitalist raising a fund, especially for first timers, can get complex, involving terminology, abbreviations, and acronyms. Here are just a few to get your head spinning: accredited investor, qualified purchaser, DPI, TVPI, IRR, LP, GP, Key Person clause, clawback, SWF, PPM, DDQ, ODD, LPA, and the list goes on. Confused yet?

I want to empower first time investors as well as people who want to learn more about the world of venture capital and the source of venture capital money. Readers should walk away with an understanding of what goes on behind the scenes with venture capitalists (referred to as VCs) and Limited Partners (referred to as LPs) during the fundraising process. The book will provide insights and perspectives from my experience as an institutional limited partner. If you have ambition and the willingness to commit to raising and managing a venture capital fund, then this is the book to help you succeed.

I will guide you through the process and help prepare you for raising your own venture capital fund—from making the initial decision to raising a fund to closing the fund. You will learn what it means to be a venture capitalist or a limited partner and the professional responsibilities attached to those titles. Are you ready for success? Then let’s get started.

Introduction

Venture Capital And The Main Players Involved In Raising A Venture Capital Fund

All the world’s a stage, And all the men and women merely players; They have their exits and their entrances.

—William Shakespeare

What Is Venture Capital?

As David Swensen defines in his seminal book Pioneering Portfolio Management, venture capital is providing financing and company building skills to start-up operations with the goal of developing companies into substantial, profitable enterprises.

Who are the main players in venture capital?

More importantly, venture capital is an ecosystem with three main players:

Entrepreneurs: who start and manage companies day-to-day.

Venture capitalists (VCs): who finance entrepreneurs.

Limited partners (LPs): who finance venture capitalists.

In this book, we will focus on the VCs and LPs and the relationship between the LP and the VC when the VC is raising a venture capital fund.

Who Are The Main Players In This Book?

Venture capitalists

Venture capitalists (VCs) manage a venture capital fund and make important decisions about when to make an investment and when to exit an investment. Their role may also include working closely with the companies in which they invest, such as providing strategic advice and helping with recruiting and hiring.

Are you an emerging or established VC?

LPs will distinguish between VCs who are relatively newer to investing (emerging VC) and those who have been actively investing for a longer period of time (established VC).

Emerging VC: An emerging VC typically refers to a VC that does not have a proven track record over a long period of time. A track record is a history of investments into companies. Usually the term emerging VC refers to any VC before her/his fourth fund, because it usually takes at least two or three funds for LPs to understand how good of an investor a VC is. At a high level, the common refrain of fund one is raised on relationships, fund two is raised on momentum and to support the manager when there is still little data, and fund three is raised on the data of fund one, which begins to determine for the LP whether the VC is good at investing.

Established VC: An established VC, on the other hand, has a proven track record because they have been investing into companies for a longer period of time and can point to their attribution and success stories of investing early into successful companies. Established VCs typically already have a brand in the venture capital market that is recognized by entrepreneurs and LPs, and they may also have sold one or several companies so there is a history of success. This book is not going to cover established VCs because they can raise capital more easily because of the established track records and relationships they already hold with LPs.

Does your background matter?

Backgrounds matter but can vary. Three famous examples of VCs with different backgrounds are Mike Moritz (a VC at Sequoia), Bill Gurley (Benchmark), and Marc Andreessen (A16Z). Mike Moritz has a background in journalism, Bill Gurley has a background as a Wall Street research analyst, and Marc Andreessen has a background as a software engineer and entrepreneur. In terms of the right background or set of experiences for a VC, there is no right or wrong recipe. Rather, VCs can come from many different backgrounds and be successful, meaning they generate return on capital for their LPs. It comes down to being able to show LPs you have mastered the craft of venture capitalism and can source, access, manage, and eventually make money persistently by investing as a venture capitalist.

Limited partners

Limited Partners (LPs) are the people and institutions that invest into venture capitalists. A close friend of mine and a long-term VC defined it well in a joking manner: limited partners are not called ‘limited’ because of their intellectual capacity and skillsets; rather, the term ‘limited’ refers to the fact that LPs have limited liability when investing into a VC fund. That is, LPs are limited in how involved they can be in the day-to-day operations of a venture capital firm. Being too involved in the day-to-day operations of a VC firm can change the legal liability status of a limited partner, so it is best for the LP to defer to the VCs who manage the day-to-day operations of the VC firm. The following list includes the most popular types of LPs. We will not dive too deep into any particular type of LP, but it is wise to note that LPs have different preferences and reasons for investing into VC funds.

Banks

Banks can have dedicated teams that invest in venture capital funds, usually through an investment division at the bank or through affiliated wealth managers. Banks can invest for strategic reasons (e.g., financial technology) or financial returns. An example of a bank that invests in venture capital funds is Goldman Sachs.

Corporation (or corporate investor)

A corporate investor can include an organization from a wide variety of industries, including software. An example of a corporate that invests in venture capital funds is Google.

Endowment

An endowment is a non-profit organization that supports an organization, such as a school. Examples of well-known endowments that are LPs in venture capital include Yale University, Princeton University, and Stanford University, among others. Endowments can also be other organizations, such as churches. Endowments share lots of similarities with foundations as non-taxable, donor-backed organizations that support charitable efforts, though there are some operational, legal, and tax differences between the two that we will not go into in this book. Unlike foundations, endowments can sometimes have multiple constituencies and therefore be more political. Endowments can also have fewer restrictions than foundations and therefore at the margin make riskier investments, which can be a positive for those looking to raise risk capital for a venture capital fund.

Family Office (FO)

Family offices are private wealth management advisors that serve a single family or ultra-high net worth individual, which, by definition, is an individual with at least $30 million to invest. Yes, some families have so much money that there are companies formed to serve that one family in terms of managing and diversifying their wealth.

Fund-of-funds

A fund-of-funds is an investment strategy that involves investing in other investment funds: a fund to invest in funds. For their own LPs, fund-of-funds offer broader diversification in venture capital.

Foundation

A foundation is a non-governmental, non-profit organization that is tax-exempt. Foundations share lots of similarities with endowments as non-taxable, donor-backed organizations that support charitable efforts, though there are some operational, legal, and tax differences between the two that we will not go into in this book.

High Net Worth Individual

Sometimes high net worth individuals are referred to as high net worths, HNWs, or HNWIs. Sometimes high net worth individuals are broken up into tiers, including UHNWs, which stands for ultra-high net worths. The important part is to think about how much investable money an individual has to commit to your fund over time. There are even legal definitions to make sure individuals don’t spend all of their money on illiquid venture capital. For example, a HNW has to be an accredited investor, defined in Rule 501 of Regulation D (see SEC website for the technical definition). That is, to invest in venture capital funds, there are legal rules to ensure the HNWI can cover these investments without causing severe adverse effects for the HNWI if her investments lose all their value.

Insurance Companies

Insurance companies collect premiums that are invested before payouts, including investments into venture capital funds.

Multi-family Offices (MFO)

In addition to single family offices, there are also multi-family offices, which are private wealth management advisors that serve more than one ultra-high net worth family.

Outsourced Chief Investment Officer (OCIO)

Outsourced chief investment officers, also known as outsourced CIOs or OCIOs, are companies that manage and make investment decisions on behalf of client portfolios. These clients can be ultra-high net worth individuals, family offices, or other investment institutions, such as pension funds, endowments, or foundations. OCIOs can make investment decisions on behalf of their clients, for example, deciding to invest in venture capital funds.

Pension Fund

Pension funds can include corporate pensions, public pensions, and other types of pensions. The value of pension funds in just the U.S. alone is massive, with the total of all U.S. pension funds valued in the trillions of dollars. For this reason, pension funds typically only invest in larger venture capital funds.

Sovereign Wealth Fund (SWF)

A sovereign wealth fund, also known sometimes as a sovereign investment fund, is a state-owned investment fund that can invest in alternative assets such as venture capital. Countries can have one SWF or multiple SWFs; for example, Norway has two main SWFs, and Singapore has two main SWFs. SWFs can be very large, too; for example, one of the SWFs controlled by Norway is valued at over $1 trillion. Because of their size, sometimes SWFs can invest billions of dollars into venture capital funds at a time. When interacting with smaller sized venture capital funds, SWFs typically require a specific mandate to invest in venture capital, or they need to have some strategic reason to invest in venture capital.

Venture Capital Funds

Wait, what? VCs invest into other VCs? Yes, this is actually