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How to Find Limited Partners: Utilizing Connectors

A connector is a person who can give you warm introductions to relevant potential investors in your fund. Typically, connectors have existing relationships with wealthy individuals, and as such, they can introduce many potential investors to you. Warm introductions usually have a higher success rate, therefore utilizing connectors can be a very powerful tool. These connectors can be exited Founders, Venture Partners, other General Partners, Limited Partners, and general High Net Worth Individuals (HNWIs). By utilizing connectors, you can leverage more nodes in the network and drastically increase your exposure to potential investors, consequently further boosting your chances of closing your first fund successfully.  

Types of Connectors

Founders

Successful and exited startup Founders can be a good resource for new fund managers, as such Founders’ opinions are incredibly valuable to LPsSpeaking with VC LabCourt LorenziniLP in over 15 VC firms and Co-Founder of DocuSign, shares that he often speaks with Founders of warehoused deals to aid his decision-making. During his deliberation process to finance a new fund manager, much like many LPs, he too looks to ascertain why Founders chose to work with you over other VCs. Consequently, getting references and introductions from Founders who have had significant markups can go a long way to impressing any potential LPs. Many LPs in Venture Capital firms are also direct investors in startups.

It is highly advantageous to have a list of such Founders to call upon since most exited Founders are wealthy and more comfortable with the asset class than most; therefore, they may be willing to invest in your fund themselves. More often than not, successful Founders may also have great relationships and a direct line of communication with HNWIs and Family Offices and can potentially connect you to others who might be interested in becoming an LP in your fund. 

If you do not have a vast network, providing value to Founders is a great long-term strategy to build these relationships. Note that this can take quite some time, though it is advisable to start developing your network as soon as possible. You can add value to a startup in equal parts, both as an investor and an advisor to the company. Such acts will enable you to build a deep-rooted network within VC and can expedite fundraising in the future.

Other VCs

Other General Partners and Venture Capitalists can also prove to be a great source and means of meeting new Limited Partners. Once again, it would be best if you looked to leverage your network and get introduced to Limited Partners. For example, if you attend VC Lab, you can discuss the matter with your cohort peers and work towards a mutually beneficial outcome. One way you can do this is to be open with your LPs and give introductions to other General Partners. When making introductions and asking for them, make sure that all parties have opted into the introduction and you follow the expected etiquette. It’s often best to practice making this as less transactional as possible and optimizing to provide value to all parties involved

Venture Partners

A Venture Partner is a well-networked strategic partner that typically does not reside within the Venture Capital firm. As such, they are a valuable resource for NextGen VCs in multiple functions, one being fundraising. These terms are outlined in the Venture Partner Agreement and can be modified to suit both parties. You can adjust levels of commitment from the Venture Partner and agree upon fair compensation and commission for the results they produce via carry in the fund

Therefore, as a new manager of a Venture Capital firm, it can be highly beneficial to make tactical alliances with Venture Partners. LPs too can look positively to such individuals who can share their expertise with the firm and both source deals as well as help you fundraise. Venture Partners are increasingly becoming the new source of labor in Venture Capital and are proving to be extremely valuable to NextGen VCs and are something you can consider utilizing.

Approach 

When looking for potential LPs, you can refer to our ‘Conducting Cold Outreach guide to help you find them on the internet. Specifically, you can utilize LinkedIn and search for relevant 2nd-degree connections in your desired region. When searching for limited partners, you can adopt a sound CRM system to track your process and leads. This CRM system can be a spreadsheet or specifically tailored softwareNote your relevant existing connections to the potential LPs you want to engage with during the process. For example, if an ex-colleague is a mutual connection, you can make a note of that in your CRM to the particular LP, as you will reach out to your references in the near future for an introduction. 

Before reaching out to your connections for introductions, you can research why each LP is relevant to your fund. Look for pertinent qualifiers that make them suitable. For example, if they have previously invested in fund managers with a similar focus / sector or in the pre-seed to seed stage. This research will make your ask more compelling as you can demonstrate your knowledge in your messaging to your connection. By such a demonstration, you give connectors confidence that you too may be a person of interest to the investor and worthy of connecting.

Messaging

Nathan Beckord, CEO, and Founder of Foundersuite, recommends that when messaging your connections, you place emphasis and on your messaging, both in the question you ask and the knowledge you demonstrate. The typical “Is there anyone I should speak with?” question does not elicit a response from connectors. If you do not know what you are looking for, neither will others. Instead, Nathan recommends you utilize your research on LPs and demonstrate your knowledge of them in your outreach to connectors. The goal here is to invoke a positive response by having a clear ‘ask’ and establishing the investor’s pertinence

For example, you may ask for an introduction to a list of 4 potential investors from one particular connector. It will help if you explain why each specific investor is relevant to your fund in your messaging to the connector.

As an example, in your outreach, you can mention:

John Doe – has previously invested in a pre-seed stage VC firm in our area of focus

Joe Bloggs – states in his profile that he is looking to invest in new fund managers

Jess Schmoe – has spoken about our area of focus extensively and has relevant experience

Jane Smith – is a co-investor in one of our warehoused deals

This content is provided by VC Lab, the venture capital accelerator. 

The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch over 100 venture capital firms around the world.

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How to Find Limited Partners: Leveraging Your Network

Launching a VC firm can be a demanding undertaking. New fund managers face many challenges, including fundraising and finding new LPs. Even with a vast network of investors, fundraising can prove to be a challenging task, so the process can become more arduous without deep-rooted connections in Venture Capital.

Difficulties can arise as many LPs prefer to stay anonymous and do not publicly share their investment status’, objectives, or activities. In our ‘How to Find LPs’ series, we guide new fund managers to leverage and expand their networks. This article will briefly outline ways to leverage your existing network and offer some ways to gradually grow your connections within Venture Capital. When doing so, it would be advisable that fund managers care to avoid general solicitation.

Leveraging Your Network

To run a successful fundraising campaign, it is recommended that you and your partners engage with your network of GPs, Founders, friends, and family. Typically this will be the primary source of your fundraising efforts if you have a vast network. We find that the amount you can raise from your internal network is a significant determinant of your total fund size. Therefore, we advise that you multiply your hard commitments from your inner network by a factor of 10 to find your optimal fund size. Refer to VC Lab’s free Network Evaluation Template spreadsheet for guidance on estimating your ideal fund size.

Connectors

One of the best ways to meet new Limited Partners is by utilizing existing relationships within your firm to those who can connect you to potential investors. Connectors are typically well-connected individuals within Venture Capital who can open their networks to enable you to fundraise efficiently. They can become one of your greatest assets when fundraising.

Connectors allow you to leverage and add more nodes to your network and exponentially increase your ability to meet and raise capital from Limited Partners. These can be Founders, other Venture CapitalistsLimited Partners, and anyone who can connect you to a pool of High-Net-Worth Individuals (HNWIs) that are willing to invest in the asset class.  

Refer to our guide on ‘Utilizing Connectors‘ for a comprehensive breakdown to mastering this powerful fundraising method.

Events and Conferences

Events and conferences are a relatively good way to expand your network. However, your primary use of venture conferences is usually to pitch to your LPs who have made some level of commitment. Though conferences such as Slush, TechCrunch Disrupt, South by South West, and RAISE can be a great medium for pitching LPs, it would be a sub-optimal strategy to attend them for the sole purpose of finding new LPs. This is a costly mistake made by some new fund managers and can divert them from their fundraising efforts. As stated before, a large bulk of your investors typically come through 1st and 2nd-degree connections you have as well as your close acquaintances, so this can be your initial area of focus.

These conferences will play a part in your fundraising process, though it will be much later when you have found a significant amount of LPs and are in the process of pitching. When you have substantial interest from LPs, you can refer to our ‘How to Pitch Limited Partners’ article, which shines a light on this process and guides you in pitching these LPs.  

 

Cold Outreach

Even when you are not fundraising, you can aspire to expand your network and build new relationships. Cold outreach can be an effective way to do this and is utilized by some of the most seasoned Venture Capitalists. The caveat is that running a cold outreach campaign can be meaningless unless implemented correctly. In your cold outreach, you can target HNWI and Family Offices, as typically, they are the most suited investors for new fund managers. This is outlined in our article “The Best LPs for New Fund Managers“. Typically, large institutional investors and endowments do not invest in new fund managers who manage small funds. Therefore it is un-optimal for you to focus your efforts in building long-term relationships there.

When focusing on HNWIs and Family Offices, you can be very particular in whom you target and your messaging as to not generally solicit. Remember that the goal here is to build long-term relationships and not advertise your fund to the masses. As previously mentioned, LPs can be very illusive and hard to find on the internet. To master the process of finding new LPs and converting them, refer to our other guide in our How to Find LPs series on ‘Conducting Cold Outreach.

This content is provided by VC Lab, the venture capital accelerator. 

The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch 83 venture capital firms around the world.

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The Rise of NextGen VCs

Who are NextGen VCs?

NextGen VCs are a new class of early-stage investors emerging amidst a set of tectonic and transformational shifts in the venture capital industry. We are witnessing a historic moment as NextGen VCs are redefining the venture capital industry and changing the underlying motives, relationships and practices within Venture Capital. These new fund managers are often masterful marketers of their firms and personal brand; they are also deeply passionate about positively impacting the world through their actions and their portfolio companies.

A Changing Industry

As we are seeing the atomization of venture firms that have faltered in their succession of partners, an increasing number of solo capitalists are launching enduring venture capital firms around the world. Simultaneously, we’re seeing a gradual shift in the type of VCs founders are opting to work with and NextGen VCs are a perfect fit for the changing preferences of startups and founders.

NextGen VC Thesis

NextGen VCs we work with at VC Lab are often built on and share three common guiding pillars

  • These VCs are highly networked individuals who are domain experts in the funds’ area of focus. This enables them to source great deal-flow and raise capital efficiently.
  • Furthermore, NextGen VCs are ethical investors who place an emphasis on having a positive impact on the world. 
  • Lastly, as part of their thesis, they utilize their domain expertise to add value post-investment by forming deep and long-term working relationships with founders to bring products and services to market.  As such NextGen VCs are able to be laser-focused and hands-on in the companies they invest in.

Not only are these a defining characteristic for NextGen VCs but they’re also proving to be a competitive advantage against traditional firms. Consequently,  in conjunction with the changes we are seeing in venture capital, early-stage founders, particularly in Pre-Seed to Series A, are now opting to work with highly specialized and networked domain experts who are uniquely placed to add value post-investment, over providers of undifferentiated capital.

NextGen Strategy

NextGen VCs have a focused strategy to both capturing and creating value in the market. They use their deep-rooted networks to both add value to portfolio companies and run effective fundraising campaigns for their VC firms.

These VCs often run a lean operation and are able to transform their vast networks to source compelling deal-flow. This is another component of their growing appeal to limited partners. Another appeal is due to the fact that smaller funds often achieve higher return multiples than their larger counterparts.

NextGen VCs are also following an evolving model of venture capital. For example, we are seeing the use of Venture Partners become an increasingly popular partnership model for NextGen VCs. By partnering with other well-connected industry experts, they are leveraging more nodes in the network to source deals and fundraise. Furthermore, these VCs are building new ecosystems to support previously overlooked spaces and committing to support them in their growth.

NextGen Future

NextGen VCs strategy is often that of value add and venture building. Speaking with VC Lab, Andy Zain who is a NextGen VC and Managing Partner at Kejora Capital, South East Asia’s Number 1 performing fund, explains that their ‘hands-on synergy’ thesis is what has enabled them to succeed and go from $5m to $600m AUM in 8 years.

However, this strategy is not new. Some of the most successful venture firms in the world have used aspects of this strategy to become market leaders. For example, Don Valentine, founder of Sequoia Capital, has stated in his talk at Stanford University, that their strategy when starting out was to back big markets and also focus around a particular pre-defined category while supporting the growth of that ecosystem. 
NextGen VCs are now taking the mantle and continuing to redefine the strategy and value proposition of venture capitalists around the world.

What does NextGen mean for you and how do you think the industry will be impacted by the new class of VCs?

Get in touch with us below!

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Venture Capital Micro-Funds

As we are seeing NextGen VCs giving rise to new micro-funds, the venture capital industry is experiencing a shift in momentum. With changing founder preferences in the pre-seed to Series A stage, a new lineage of venture capitalists are launching their own firms with contemporary hand on theses, offering founders much more than capital. Coinciding with said shifts, parallel transformations are also occurring with limited partners in these stages of venture capital.

What are Micro-funds?

Micro-funds are much smaller than usual venture capital funds and are typically below $30m and usually write checks anywhere from $25k-$500k. These new funds are being formed to cater to the monumental increase in the number of startups that are typically underserved in early stages (Seed to Pre-Seed) across the globe. We are seeing that they are often managed by specialized domain experts who have deep-rooted networks in a particular industry and are guided by a governing set of beliefs to improve the world via ethical means. Via their micro-funds, they develop a track record of success and build enduring VC firms.

Changing Market Conditions 

Though the venture capital asset class is seeing increasing amounts of growth and investment, these statistics are largely a result of the spike in mega-deals seen in the later stages by large growth funds.  Consequently, a gap still exists in the earlier seed stages of venture capital, where many founders and startups often get overlooked. So, though the asset class is thriving, the latter stages are dominating the industry, and the ‘top-heavymarket imbalance is a contributing factor to the rise of micro VCs as well as NextGen VCs

Simultaneously, a metamorphosis is occurring in early-stage venture capital LPs. While High Net Worth Individuals are discovering the many benefits of becoming LPs in Micro-funds and are transitioning away as full-time angel investors, Family Offices have increased their exposure to the asset class. UBS in their 2021 Global Family Office Report highlight that 61% of Family Offices now make venture capital investments as shown below and more are willing to invest in the early seed / pre-seed stages.

UBS FamilyOfficeReport
https://www.ubs.com/global/en/global-family-office/home1/private-equity.html

This is further contributing to the overall shift the industry is experiencing and giving a supplementary boost to the climate in which Micro-funds can flourish.

The Rise of Micro-funds

As discussed, the climate for both NextGen VCs and Micro-funds is becoming incredibly favorable. As smaller and leaner venture capital firms, NextGen venture capitalists and their unique theses to capture value, often in overlooked markets and categories is proving to be invaluable to founders. As well-connected domain experts, they are able to offer invaluable guidance to their portfolio companies. As such, much like a lean startup, they are disrupting traditional generalist VC firms and forming deep bonds with founders while offering pivotal hands-on guidance

New Avenues of Funding

The disruption is creating tidal waves, so much so that a new breed of LPs is starting to emerge to cater to this new segment of VCs. Fund of Funds that specialize in micro VCs are emerging to specifically fund these NextGen VCs. Increasingly, new and emerging fund managers are becoming a compelling option for Limited Partners, due to their favorable terms as well as their superior performance. Statistically, top-tier new managers tend to outperform their existing counterpart fund managers and especially mega-funds. It is clear that a market opportunity exists for more specialized fund managers to enter the market and form micro-funds to cater to a niche market of founders, who are opting for a hands-on approach as opposed to undifferentiated capital

At VC Lab we are seeing the many success stories of NextGen VCs and micro-fund managers fuel a new set of investors to launch their own enduring venture capital firms. We expect this trend to continue and provide a monumental shift in early-stage venture capital in the years to come and as champions of NextGen VCs, we welcome aspiring fund managers to join this movement.

This content is provided by VC Lab, the venture capital accelerator. 

The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch over 100 venture capital firms around the world.

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Venture Capital Deal Memo

What is a Deal Memo?

Deal Memorandum documents are an important part of the investment process within venture capital firms. Deal Memos document the key facts of the company, deal, and at times make an investment suggestion to the investment committee

What is it used for?

i) Structure Thinking 

Deal Memos allow VCs to structure their thinking and find alignment between the company in question and the firm’s thesis. They enable you to capture your assumptions pertaining to the deal at genesis while systematically validating/invalidating said assumptions. Consequently, they allow VCs to map out their hypotheses while documenting and weighing the rationale to invest in a company. VCs are able to look at the Deal Memo and quickly find alignment or lack thereof and come to a decision. 

That decision can often be to engage further and meet the founders in the early stage. Later on, it can be to conduct further due diligence on the facts as stated in the companies pitch. Deal Memos alone seldom lead to investment and there is a process each firm takes to get to a decision to invest. 

ii) Collect Diligence

This also allows the firm to look at the various aspects of the business and collect diligence. As part of the VC’s fiduciary duties, fund managers should conduct diligence and take necessary steps to ensure all investments are in accordance with both the firm’s thesis and what was marketed to LPs when fundraising. 

Therefore, Deal Memos are central to the due diligence phase. Having this information readily available in a document allows decision-makers to make informed choices during the investment process and fulfill their fiduciary responsibilities.

iii) Share Facts

Importantly, Deal Memos are a medium on which venture capitalists share and document the facts of a deal. They are used to summarise the deal in a concise manner and enable others to quickly catch up on the key facts and evaluate the company.

These documents are circulated around the stakeholders and the key decision-makers both internally, as well as with vendors and venture partners to deliberate. Typically the partners who sit on the ‘Investment Committee’ are those who vote on deals that come into the firm. This is outlined in depth in our VC Roles Article.

iv)  Memorialize Assumptions

These documents also memorialize the thinking of the VC and allow the firm to evaluate and analyze the assumptions that are made at the time of making a ruling. This is very important as it enables the firm to go back and re-evaluate the reasons behind their decision. 

It is essential for a venture capital firm to continually reassess its thesis and assumptions from first principles. Consequently, revisiting your past hypotheses and deductive reasoning is crucial to refining your decision-making process. This enables you to isolate assumptions and determine whether they were accurate. Therefore it is advised that VCs revisit both successful investments as well as their anti-portfolio to take learnings from and adapt to the market.

Who writes them?

The author of the Deal Memo can depend on the situation. Though partners are the ones to vote on a deal and write checks, in large established VC firms this task can fall on more junior members such as Associates and Analysts

A pivotal point to take note of is the source of the deal. Typically, said junior members screen incoming deals into the fund and produce Deal Memos for the top percentile of incoming deals. On the other hand, a partner may also choose to write a Deal Memo for a deal they’ve sourced and are championing to the committee

What makes a good Deal Memo?

We believe that central to a good Deal Memo is information regarding the founder / team, market size, company growth metrics, and the deal momentum / dynamics.

Note that Deal Memos are not standardized across stage, firm, or geography. Each firm has its own set of preferences and there is an overall lack of transparency in the industry. The contents and complexity of the Deal Memo can therefore depend on a plethora of factors.

Typically, Deal Memos need to be concise and informative in the early stages of consideration and a simple one-pager will suffice in screening. In the later stages of consideration, they need to be more comprehensive and metric-driven and the analysis should be in-depth and backed by data.

Consequently, the venture capitalists can collect information over time and continue to evaluate the deal while providing guidance and assistance to the founders of the company

An example, you can refer to is Roelof Botha’s Seed Stage YouTube Deal Memo for Sequoia. Here you can see the increase in detail and analysis as the deal moves along the investment process. 

VC Lab’s Deal Memo Template

The venture capital industry lacks transparency /openness and VC firms typically tend not to share internal resources into their investment process.

At VC Lab we are committed to democratizing information and access to the venture capital industry. As such, we invite you to share your opinion and give feedback on our open resources

Find below our Deal Memo template and join us in creating an open and transparent set of resources for both venture capitalists and founders by sharing your feedback and suggestions in our live document below. 

Deal Memo V1.0

Additionally, we welcome your thoughts on what makes a good Deal Memo as well as this article. You can also share your insights by commenting below.

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Venture Capital Deal Warehousing

Successfully launching your enduring venture capital firm is a challenging but incredibly rewarding task. Fund Managers raising their first venture capital fund will have to familiarize themselves with the concept of ‘deal warehousing’ to get to a close. This process involves many tricky intricacies which we will guide you through in this article. 

What is Deal Warehousing? 

So, what is deal warehousing, you may be asking yourself. Simply put by Richard Gora, Attorney at Gora LLC:

Warehousing is an investment interest that you acquire before forming the fund

Richard Gora

It can be beneficial to warehouse a portfolio of deals and have them in storage when launching a VC fund.

There are essentially two categories of warehouse deals:

(i) The primary type of warehoused deals are companies in which you personally have equity, whether as an angel investor or advisor. You typically incorporate these deals at the stage of fund formation and their value can be used as part of your capital contributions

(ii) The second are deals that you plan to invest in as a venture capital fund, provided the founder has agreed to hold an allocation for the firm. These deals are done post-closing of the fund after LPs have met their capital contributions.

Benefits of a Deal Warehouse

The primary benefit of warehousing deals is to de-risk the fund by enabling LPs to participate in marked-up deals at lower valuations. Typically, when your personal angel investments (which you’ve moved into the fund) get marked up in future rounds, LPs will reap the benefits of the markup as members of the fund. This in turn de-risks investments into your fund from the LP’s perspective.

Furthermore, warehoused deals are a great signal to LPs of the caliber of your deal-flow and enable you to demonstrate congruence to your pitch and thesis. Having warehoused deals that have been marked up valuations in later rounds which also fit your thesis is an exhibition of your ability to perform as a fund manager.

When speaking with VC LabCourt Lorenzini, co-founder and ex CEO of DocuSign and an LP in over 15 venture capital firms said…

In evaluating a manager in the early stage, I firstly look at their deal warehouse, if they have any.

Court Lorenzini

Court continues to explain the benefits of a deal warehouse from the LPs perspective and says…

“I look at what those companies look like and talk with a few founders to see what really attracted them to this particular manager. I want to see if they have access to deal-flow that I want and but am currently not exposed to.”

Best Practices

Under the Investment Advisers Act of 1940, venture capital fund managers are bound by duties of care and loyalty to the individuals whose money they are managing called “fiduciary duties”. In short, complications can arise when transferring personally held assets into the fund, as it can form conflicts with a fund manager’s Duty of Loyalty, which states that “fund managers must not subordinate their clients’ interests to their own.” 

To avoid such complications, it is advised that fund managers do not “cherry-pick” investments from their portfolios when choosing which companies to transfer into the fund. Instead, fund managers should transfer companies based upon the fund thesis which was marketed to limited partners whilst additionally disclosing said risks and conflicts

Finally, when adding companies into the fund,  it is advised that fund managers do not “mark-up” valuations of said companies and instead place them into the fund at cost

This content is provided by VC Lab, the venture capital accelerator. 

The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch over 100 venture capital firms around the world.

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Fiduciary Duties of Venture Capitalists

Venture capitalists are having an increasingly positive impact on the world in improving the lives of countless people around the globe and we are now seeing NextGen VCs take up the mantle to accelerate this change. At VC Lab we provide free resources to champion next-generation venture capitalists and help you successfully launch your venture capital firm. One of the things new fund managers should be aware of when launching a venture firm is their ‘fiduciary duties’ to their limited partners.

A ‘fiduciary’ in this context is an individual or organization that manages assets on behalf of others (the LPs).  Under the Investment Advisers Act of 1940 (the “Advisers Act”) by the SEC, said parties are obligated not only contractually but also by a duty of care and loyalty / fidelity whether or not they are registered with the SEC. Note that venture capital fund managers fall under this definition and as such you are considered an ‘investment adviser’ by the SEC

Though the ‘Advisers Act’ lacks detail as to the responsibilities of investment advisers, SEC’s interpretation within the ‘Standard of Conduct for Investment Advisers’ (SCIA) goes on to outline the encompassing fiduciary duties that venture capital fund managers should follow.

  1. Duties of Care
  2. Duties of Loyalty
  3. Common Complications
  4. Waivers

Duties of Care

In section II.B. of the SCIA, the SEC breaks down the Duties of Care into 3 core responsibilities:

  1. Duty to Provide Advice that is in the Best Interest of the Client

To do so, the advisers should understand the client’s objectives, e.g for retail investors their investment profile, and for institutional investors their investment mandate. Therefore, fund managers should make reasonable inquiries into the client’s financial situation and sophistication. When managing a client’s capital, advisers ought to have reasonable belief that their actions are following said goals of the client. Consequently, venture capital fund managers should ensure their LPs are highly sophisticated individuals with an understanding and tolerance of the risks associated with the asset class.

  1. Duty to Seek Best Execution

Advisers should have the goal of maximizing value for the client when executing securities transactions. The SEC states that the determinative factor here is not optimizing for the lowest cost/commission but whether the transaction represents the best qualitative execution. Additionally, it is recommended that fund managers should put systems in place to periodically evaluate the executions it is receiving on behalf of its clients. 

  1. Duty to Provide Advice and Monitoring over the Course of the Relationship

Fund managers who receive periodic management fees, as opposed to one-off transaction fees, should monitor the portfolio of investments for the full duration of the relationship with the clients, namely the duration of the fund

To summarise, it is advised that fund managers safeguard their client’s assets with due care for the entire duration of the fund, while always seeking the best interests of the clients and conducting the necessary due diligence on both investments and the client’s sophistication to act per the client’s objectives and the agreed-upon investment strategy of the fund.

Duties of Loyalty

Section II.C. of the SCIA outlines the duties of fidelity and necessitates that the fund manager does not subordinate their clients’ interests to their own, meaning that the client’s interest supersedes that of the fund manager’s own interest when there is a conflict between the two. Consequently, fund managers should seek to be provident and make full written disclosure to their LPs at the start of the relationship and specify any conflicts of interest that exist or might arise in the future

Fund managers should also consider the conflicts related to the allocation of opportunities among eligible clients (and describe with specific language and in detail within their disclosure, how they will manage such conflicts of interest.

Common Complications

For new venture capital fund managers, multiple complications can arise when setting up their funds and during the funds operating life. Fully disclosing personal angel investments and other notable interests to the LPs is recommended to avoid such complications.

One particular complication arises when picking a selection of a personally held portfolio of companies to transfer into the venture fund. It is advised that when doing so, fund managers act in line with the fund’s thesis as well as disclose relevant information to limited partners. 

It is sometimes not possible to predict every future eventuality and complication. For example, issues can arise when allocating investment opportunities to a co-investment vehicle or another fund. Therefore, it is advisable to create an independent ‘limited partner advisory committee’ (LPAC), which can make decisions on behalf of all the limited partners. This expedites such procedures as it means the fund manager does not have to individually deliberate with every limited partner.

Consequently, due to the conflicts of interest that arise in both managing a fund and making personal investments, fund managers are typically prohibited from making personal investments within venture capital. Other than conflicts in a manager’s duty of loyalty, further issues arise due to clauses addressing such scenarios in most limited partnership agreements. 

A limited partnership agreement (LPA) governs the actions of involved parties and sets forth the economic and control terms of the partnership. LPAs typically exclude such activities on the part of the fund manager. Refer to our lightweight and simplified Cornerstone LPA to see such terms and clauses.

Waivers

Waivers are voluntary relinquishments of a parties legal rights or claims. Typicaly they are used to mitigate the potential liability of a party.

Fund managers should note that the SEC has warned that any effort to avoid such complications as discussed previously via the use of waivers would be inconsistent with the Advisers Act. This includes any documentation “to waive the fund managers federal fiduciary duty such as

(i) a statement that the adviser will not act as a fiduciary,

(ii) a blanket waiver of all conflicts of interest,

(iii) a waiver of any specific obligation under the Advisers Act.”

Consequently, fund managers should not include any such waivers in their fund documents to bypass the aforementioned legislation. Doing so is not advised and may lead to legal complications and liabilities for the fund manager and the venture firm.

Sources and additional resources: 

This content is provided by VC Lab, the venture capital accelerator. 

The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch over 100 venture capital firms around the world.

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Cornerstone LPA

Cornerstone LPA Update v1.1

The Updated Cornerstone LPA further improves on key terms to give fund managers more flexibility. VC Lab has additionally consolidated essential sections while enhancing the overall readability of the document.

Key Updates:

KEY ECONOMIC TERMS

  • No major updates have been made to previous key definitions in this section.
  • Newly added definitions are:
    • Fund Thesis
      • Sector
      • Stage
      • Geography
    • Management Fee
      • As requested by fund managers, we’ve added a flexible ‘cascading management fee structure’ while improving readability

ARTICLE 2 – CAPITAL ACCOUNTS AND PARTNERS

  • 2.2.2a – Capital Contributions
    • Removed post investment capital contribution limitations giving fund managers the option and flexibility to call capital post-investment period
  • 2.3 – Default
    • Updated to enable GPs to take more actions regarding defaulting LPs
  • 2.5 – Additional Limited Partners
    • Updated to enable GPs to bring in additional LPs after the close
      • Requiring said LPs to be on the same capital call schedules as other LPs and partners

ARTICLE 4 – OPERATIONS

  • 4.1 – Investment Objectives
    • Improved follow-on investment language
  • 4.3 – Authority of GP; Key Individuals; Conflicts of Interest; Advisory Committee
    • Tightened up conflicts of interest language
    • Flexibility to follow on investments with Special Purpose Vehicles (SPV)
  • 4.92 – Management Fee
    • Update to payable management fees 

ARTICLE 7 – SUBSCRIPTION

  • Added new Cornerstone subscription section
    • Conjoined from multiple sections to clearly define here 

ARTICLE 8 – MISCELLANEOUS

  • Consolidated key terms: 
    • 8.2 Power of Attorney
    • 8.3 Side Letters
    • 8.4 AML and Combating the Financing of Terrorism
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The Best Limited Partners for New VC Firms

As the Next Generation of VCs enter the market and look to build enduring venture capital firms, they should be aware of which types of limited partners to focus on when marketing their new venture firms.

Not all LPs and investors in venture capital firms are the same. Each type of LP has their own preferences, so when marketing your venture firm, you should take these into account. For example, large institutional LPs such as endowments rarely invest in new venture fund managers and their firms. Since such institutions are managing vast sums of money, it is un-optimal for them to write small checks and have small VC firms in their portfolio. Large institutions also have very lengthy procedures and are relatively slower than their counterparts.

Typically, you will find that HNWIs and Family Offices are the best source of capital for new venture capital firms and as such we will mainly direct our focus into those two categories in this article.

Table of Contents:

Each of these types of LPs has a subset of differing profiles. When targeting them, fund managers should tailor their pitches and take into consideration the LP’s appetite for risk or lack thereof. Additionally, factor in the LP’s preferred stage of investment as well as the markets they want exposure to.

It may be a waste of the fund managers’ time if several key prerequisites are not aligned. Therefore, it is vital to establish an alignment of said criteria early on, in order to be efficient at fundraising.

High Net Worth Individuals

HNWIs are wealthy people who typically manage and allocate their own capital into assets. This group of individuals is hard to pin down into a single profile and their goals may differ considerably

You may find that successful entrepreneurs who have had exits in the past are much more willing to back new fund managers and firms. Angel investors are a good avenue for new fund managers too, as they also have exposure to the asset class and understand the risks and returns. High-ranking individuals within adjacent corporate investment and finance sectors may also be receptive and open to having some exposure to the asset class, in an effort to diversify their assets.

Overall, HNWIs are a great backers for new firms and are more likely to back new fund managers relative to the other class of limited partners. Comparatively, they are more likely to come into a first close for the firm. Their ticket size is very dependent on the individual, but they are much more efficient in writing checks than large investment offices, corporate businesses, and institutional investors.

When targeting them, it may be best to find LPs who are experienced in the firm’s segment of focus. This way such an individual will be familiar with your domain of expertise and able to evaluate your thesis, thus take much less convincing. They will also be able to support portfolio companies and add value post investment.

Family Offices

Family offices are wealth advisory firms that exclusively serve families or ‘Ultra High Net Worth Individuals’. These offices are set up to fulfill an extensive range of services for said families and individuals, who typically have a net worth of over $100m, as to necessitate the formation of a family office. Such family offices vary in size, focus, sophistication, and other factors.

Single Family Offices‘ conventionally manage the wealth of a sole family / individual so are highly tailored and focused on a particular family’s requirements.

‘Multi Family Offices’ manage the capital of multiple sources and so staff work across multiple accounts and families. Since they have multiple clients, they can cater to individuals with less capital and have a broader focus and set of services.

Family offices are great LPs to focus on for new managers as they are much more willing to be the first checks into backing new and emerging fund managers.

Region and the size of the family office play a large role in the likelihood of said offices backing new fund managers as not all family offices invest in venture capital. In terms of strategy, some family offices tend to be oriented around wealth preservation. They are less likely to invest in the venture capital asset class and new / emerging fund managers. Typically, European family offices tend to have a wealth preservation focus while those in the US have a more aggressive strategy that favors venture capital.

Small family offices are more likely to back new fund managers and are more efficient in writing checks and coming into a first close, while much like large institutions, large family offices are less likely to do so.

Corporates

Corporate businesses / investors are not very likely to back new fund managers. Efforts to convince corporates typically do not yield a positive outcome in the short term unless the business is looking to enter a particular niche via the venture firm. The process of getting funding from a corporate business is also much longer than most LPs. Since most large businesses are relatively slower in writing checks for VC firms, the fund manager has to navigate a very arduous and bureaucratic process

New fund managers should focus on LPs with a higher probability of success when launching their enduring venture firm.

Institutions

There are multiple subsects of institutional investors. Fund of Funds for example have specifically been raised to invest in venture capital firms. These institutional investors are not likely to invest in new fund managers without a track record of success and outsized returns. However, there are some FoFs that specialize in micro-funds with new managers, which may yield a positive outcome. If targeting FoFs, fund managers should specifically target ones with similar strategies which suit the firm’s thesis. 

Other institutional institutions are also not likely to invest in new or emerging venture firms. Overall, institutional investors have a lengthy and challenging process to writing checks and new fund managers should not spend too much time pursuing them.

Summary

New fund managers should focus on HNWI and small family offices when fundraising and closing their first fund. Larger institutional and corporate investors in venture capital firms often have lengthy procedures and require a track record of success.

Relationships with larger investors and institutional bodies should be built over time and maintained. Consequently, it is prudent to be in communication with said LPs and develop a relationship early on, even though said LPs are not likely to invest in new firms. Many GPs and founders often have a binary approach to fundraising and it is better to continually nurture relationships with potential investors and keep them updated on your organization’s progress, as they may come into later funds of the venture firm. 

A large percentage of new funds’ LPs are comprised of HNWI and small family offices, so fund managers should spend a proportional amount of time with those LPs, rather than large institutional investors. 

When targeting potential LPs it is a good idea to find a regional fit. Much like venture capitalists many limited partners exclusively invest in their own domains of expertise, therefore finding an alignment may go a long way to getting funded too. If the LP has previously backed VC firms, there is a considerably higher chance of interest in your fund. On the other hand, if said office has never backed a VC firm, it might be prudent to not spend a significant amount of time convincing them 

This content is provided by VC Lab, the venture capital accelerator. 

The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch 83 venture capital firms around the world.

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Venture Capital Fund Mechanics

Those seeking to become limited partners in a venture capital fund may benefit from understanding the basic mechanics of venture capital, before going on to more advanced notions. This includes fund topics such as fees, commitments, carry, returns and structures. 

Important to note that these mechanics are often dependent on many factors such as region as well as the individual fund and what is outlined in the Limited Partnership Agreement.

Table of Contents

Structure

Venture capital funds are often structured as closed-end entities. This means that the fund has a predetermined period upon which it will dissolve and returns will be distributed to the LPs. Most VC fund periods are for 10 years as startups take time to mature and yield returns via exits / acquisitions or IPO’s. Usually, there are two years of extensions without fees. In sectors such as DeepTech, the fund duration maybe longer, as these sets of companies take much longer to mature

On the other hand, evergreen (open) fund structures have no termination date and are more liquid. However, they are very difficult to manage for small to medium funds and are usually adopted by large global multistage firms. 

Returns in both structures will be distributed to investors at the discretion of the fund manager and provided a portfolio company has yielded sufficient returns. For closed-end structures, this can also happen before the termination date of the fund. In open-end funds, the manager may choose to hold on to the asset even post IPO. 

Capital Commitments

Usually, limited partners will commit a certain amount of capital to the fund. However, important to note that the entire sum is not invested initially. Typically, a fund manager will ‘call capital’ several times throughout the fund’s lifetime; usually, this is between 20%-30%. You may also see that in some funds no single LP makes up more than 10% of the fund.

With this capital, managers will finance a portfolio of startups in exchange for equity. Consequently, though an LP is obligated to meet capital calls upon request by the fund manager, they will still be in possession of the capital up until each call. 

Partners of the fund are often expected to commit capital during calls as well. This ensures that there is an alignment of incentives for those managing the fund. Depending on the firm, this commitment on the part of the partners is around 1% of the fund.

Fees

VC funds will charge fees to run the management company. This capital is used to pay the salaries of the fund managers, the staff as well as other operational costs such as rent. 

Typically, this amount is between 1-3% per year depending on the fee structure. Over the life of the fund fees typically add up to 10-20%. At times, this number can be capped, especially in larger funds that manage vast sums of capital. 

Fees may be structured as a flat 2% per year for the duration of the fund, or, as a cascading structure that starts off higher but averages out to 2% over the fund’s lifetime.

The cascading structure is more appealing to new fund managers as the fund’s need for capital is not evenly distributed. Usually, new funds need more cash at the beginning to set up and prefer the cascading structure. Also, fund managers will construct their portfolio at the start of the fund and mostly make follow on investments in the latter half of the fund’s life, meaning they will not need as much money towards the end of the fund’s lifetime.

Carry

Limited Partners of the fund are usually entitled to their investment into the fund, after which the profits are split between the LPs and the GPs. Profit here is defined as any income after the initial fund is returned.

This split is usually a predetermined ratio of the fund’s profits, again, this is outlined in the ‘Limited Partnership Agreement’ which is signed by all parties. Typically this split is 80:20, between the investor and the fund manager, however is subject to change and negotiation depending on the track record of the manager.

Within the fund, you may observe a hierarchical structure upon which the Managing Partners sit at the top. Each partner’s level of carry and capital contributions depends on their seniority, where more senior partners are entitled to more carry but typically have to contribute more capital.

Returns

Venture capital is considered a very risky asset class as over 80% of startups fail. 3X returns are typically seen as the bar for funds, however, less than 10% of VC firms return this much capital. The funds that do outperform the market capture outsized returns. We dive deeper into this in our ‘Why invest in Venture Capital?’ article.

Though VC has outperformed every other asset class in the last 3 years, it is clear that the Pareto Principle is at work within VC funds. Limited Partners should be aware of the expected levels of returns from VC, as it differs across stage and sector of focus. It should be noted that new fund managers tend to outperform existing managers and small funds also tend to outperform very large funds.

Returns from VC funds are typically seen in 8 – 12 years. After raising a fund, managers will deploy some given percentage to construct the portfolio in 2-4 years. They will then keep the remainder of the funds capital in reserve, in order to back the winners in the portfolio. Typically VC funds will raise two funds before investors can get a good picture of how the initial portfolio is doing and so the third fund is crucial for new fund managers.

Reserves

As mentioned, VCs will keep a considerable amount of capital to back the fund’s winners. This is because of the inherent power law in VC where a majority of the returns are derived from a handful of companies. 

VCs want to keep capital in reserve in order to back their winners and keep the same percentage in ownership. These winners become abundantly clear as the fund matures and VCs usually have pro rata rights to invest in subsequent rounds. Interestingly, there is some debate among VCs about whether it is prudent to invest in new companies, rather than backing companies in flat and down rounds.