What it takes to start your own venture capital fund
It seems that becoming a VC is a dream of many, and rightly so: it’s really a fantastic job.
As a venture capitalist, you’re paid to learn as much as possible about new markets and to meet with the smartest people you can find. You get to follow along the entrepreneurial journeys of founders much smarter, determined and audacious than you are, without the massive amount of risk of having all your assets and a lot of your professional reputation tied to a single outcome. That seems like a dream job description to me.
Working as a VC associate right after school, I really got spoiled and so after 3+ years in an operational role at a startup, I decided I wanted to start investing again.
There were just a couple of problems:
- I did not have any money whatsoever to invest
- It was highly probable that no VC firm would have hired me as anything more than an associate
- I had an idea I was deeply passionate about and wanted to bring to reality:
While talking with my friend, he started suggesting we start our own fund and run it part time as “angels”.
I obviously thought he was crazy.
But dozens of espressos later, he had convinced me.
We came up with the idea of allowing our friends who are living in Europe to get exposure to the asset class of silicon valley startups.
The first person we pitched, gave us a resounding no. Not because he didn’t want to invest, but because he wanted to join our crazy adventure, and so over breakfast Mission and Market was born.
I get asked by a lot of people how they can get into venture capital. The answer is that it’s not easy given that jobs in the industry are scarce and usually reserved for people with a very specific background.
So, after having invested in more than 30 companies including Eaze andTranscriptic, I thought it might be helpful to explain what we did and why, and give a rough framework for people who want to get into venture capital by themselves.
HOW TO START YOUR OWN FUND
These thoughts are meant for people who want to start a small fund. If you’re starting a 10M+ fund, most of the below won’t apply!
1. Commit mentally
Talk to people who’ve done it before. I reached out to Semil, Zac and Shrutito understand what they did and how, and it was super helpful.
Be sure that you’re ready to commit to this for a long time.
2. Do the math!
RETURNING A FUND IS HARD!
There is plenty of money floating around startups and (as this post demonstrates) it is fairly easy to become an investor.
This means that the gold mines are getting crowded and the chances of finding that big nugget are getting slimmer. Fortunately for us, startups are not a non-renewable asset like gold, so if you put in time, effort and get a bit of luck, it still is very possible to generate meaningful returns.
But going at it without modeling out all possible scenarios is not a good idea. The math will inform a number of key decision you need to make:
- how many deals you want to make.
- what check size you’ll be writing.
- how much of the fund you will be reserving for follow on investments.
- how many follow-ons you’ll be able to do and the amounts.
Doing the math will also show you how much enterprise value you’ll have to generate in order to return the fund, and how entry valuations will impact this.
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.
The reason to make 60 investments is simple: building a highly diversified portfolio is key to having a higher chance of funding one “unicorn”, which means better returns and better brand, which leads to better dealflow, and circularly to better returns (even for potential future funds).
We’ve done 30 in our first year, and will be making 30 more in the following 1.5–2 years, and then will just use the remaining capital to continue investing in the winners.
3. Define your compensation
Given we’re doing this part-time, we decided to not take any management fee out of the fund.
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 carry, 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.
Do not expect to get rich out of this.
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.
And that’s assuming you return 3X the capital!
4. Find a solid team.
You can go at it by yourself, like Semil did, but if you want to do this while still working at a company or even running yours, it’s pretty mandatory that you join in with one or two other people.
If you think you have what it takes to go at it alone, you’re better off angel investing or doing syndicates over AngelList. Raising and running a fund is a lot of work, and should only be done if you have the time and flexibility to do it.
It’s very important to choose people that you like A LOT.
Choosing partners for a fund is even more critical than choosing a co-founder, as you’re actually writing down on contracts that you’ll work together for 10 years minimum.
It’s also pretty important to choose very smart people with a solid network and flawless reputation. Investing experience is the least of the concerns.
Francesco and Simone are the two best people I could have started this with!
5. Define your thesis and value propositions.
A thesis is not only what you’ll invest in, but in my opinion should also include the reasons you’ll do what you’ll be doing.
As an investor, you have two customers: your LPs (which act as both customers and bosses) and the entrepreneurs.
Our value proposition to LPs is access to a diversified portfolio of SF/SV-based startups with a small sum of money, which would be impossible to achieve by direct investment. European investors don’t tend to have much access to funds or startups, other than what they can do on AngelList and so it’s been a fairly easy sell.
Because of that, we don’t need a very specific thesis about the type of investments that we look at (other than the fact that they should be local to the Bay Area).
If you’re going to target LPs who already have access to deals and funds, you might want to “verticalize” your thesis on a specific edge (some special dealflow source, some industry that you’re particularly connected in or knowledgeable about, some underlying trend that will make you deliver a higher return, etc.). Read my post on the rise of the thematic VC for more thoughts on this.
But it’s for you to figure this out.
6. Define the vehicles and incorporate.
Traditional funds are comprised of a Limited Partnership (the fund itself) and an LLC General Partner (which managed the fund).
We followed this traditional model but using a simpler LLC as the fund itself.
This setup is not extremely expensive and provides good flexibility, as well as a well tested and known structure to investors, accountants, etc.
Today, there are many options that make this much simpler, the most obvious of which are AngelList Syndicates and FundersClub Partnerships. (There’s a ton of content out there on this, so I won’t go into the details here.)
We still decided to create our own structure, even if more expensive, for a variety of reasons. If we ever raise a Fund II, we’ll revisit!
If you build your own structure, get a good lawyer who’ll defer your fees until closing!
7. Get some good people doing your backoffice
We initially had a startup do our taxes and reports, and it was the worst decision we ever made. We’ve now switched to a solid backoffice firm who specializes in VC and PE funds, and it’s absolutely worth the money.
8. Start pitching!
IT’S GOING TO TAKE MORE TIME THAN YOU THINK.
LIKE, A LOT MORE TIME.
Also, it’s going to be way harder than raising money for your startup, should you know what that’s like.
So start pitching. Find all the rich people you know, and ask them to trust in you.
Accept small checks.
9. Start investing!
It’s super important to start investing as soon as possible.
If you can afford to, you should start angel investing way before your fundraise. If not, and if your structure enables you to, try to write some first checks as soon as you have enough money for them.
Investing in companies is the best strategy to get more quality dealflow, and will also help you get into other deals. It provides the foundation of your reputation and will help entrepreneurs judge you a bit better.
Additionally, showing LPs your first picks are good will make the closing process much easier.
Hopefully this is helpful to folks who are considering starting their own fund. It is a big undertaking in terms of time, money and mental energy, but it is fun and incredibly rewarding.
Best of luck to those of you who decide to take the leap!