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How to Start a Venture Capital Fund

24 Jun How to Start a Venture Capital Fund

*Or why I would suggest getting into something else.

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Getting into Venture Capital is about as difficult as getting into the NBA. Don’t count on making waves.

We’re not venture capitalists. We don’t claim to be. We don’t have a dedicated fund. We could raise large amounts of money and we have in the past on specific deals. And we know many of the places to go to tap institutional money, but we choose not to. Raising money money is a double-edged sword. That’t at least one of the reasons it’s not where we want to play.

Before I get into some of the ins and outs of starting a fund, I’m going to play Chicken Little and give my negative reasons why starting a venture capital fund may not be such a good idea. My personal take is that many of today’s dedicated family and institutional funds are poorly managed for a number of key reasons.

  1. Dedicated, contributed capital subverts discipline. We like to raise money on a case-by-case and deal-by-deal basis. In other words, the deal will need to stand on its own two feet. This forces discipline in assessing which opportunities to pursue and which to leave behind.
  2. Too much capital, too few deals. It’s a seller’s market right now in private equity and venture capital and I believe it will be for sometime. When Bain Capital and others started in private equity in the 1980s it was a new phenomenon. Between this and other sites we own, we’re contacted by no less than five or six private equity groups weekly. Simple supply/demand economics puts pressure on the equity buyers to increase their offers. It’s funny, but this model is radically different in the VC world where NO revenue and NO profit makes determining value much more difficult and will cause a knowledgeable VC to have almost all of the power in the relationship.
  3. Failure rate of VCs is already chronicled. Some VCs do very well. Most are mediocre at best and many do not do well at all.

Find a Profitable Niche 

A learned a great lesson long ago that has always stuck with me: a specialist beats a generalist every day of the week. We have a close partner in a different geographic region, for instance, whose sold VC investment focus is on the Latin American market. Their reason. First, they had done extensive research on the region and found that it was under-served for providing venture money. So, finding better deals with good upside potential was much easier because the competition behind each deal was much lower. Second, this particular firm had contacts, experience and language expertise for the regions they decided to target–which would be an absolute must. It was a perfect win-win for the firm.

What’s your company niche? How will you determine to differentiate from others in the VC fray? –because you’ll have to if you want to be successful long-term.

Have Experience

This should probably be number one. You can’t get money without experience and you typically can’t claim experience as a twenty-something. Institutional money doesn’t flow that direction. In addition, experience can also come in many forms. The fallacy that the Ivy League adds an extra decade onto experience is still prevalent, but in some cases a good filter. More important to most venture capital funds is the school of hard knocks.  To be a true venture capitalist most have worked as entrepreneurs. Let me rephrase, most have worked as very, very successful entrepreneurs. In short, one of the best ways to showcase experience is to start a successful technology company, grow the business into millions in revenue and subscribers and sell it off to a very large publicly-traded company for a large sum. Granted, it’s much easier said than done, but for procure truly institutional money, this type of experience (even in a small way) is most assuredly a pre-requisite.

Furthermore, the institutional money folks will also want to see a track record for investment analysis and assessing deals and opportunities. Having someone like that on your team will be another necessity. Perhaps your specific business experience does not translate into other tech companies and making investments across a broad swath of smaller companies to which you’ll be investing.

Procuring the Capital 

Raising capital will either be the easiest thing you do or the hardest part of the process, depending on the your experience mentioned above. Engage, Filter, Rinse, Repeat Engaging with firms is easy. The only problem is that you have to kiss a lot of frogs. We get opportunities pitched to us fairly regularly whose business plans are either terrible or worse, the operators of the businesses are atrocious. Most would agree that they would fund the A-team with a C-idea. A-ideas are prevalent, but if the IP is owned by a complete idiot with no business or social acumen then it’ll be best to leave it be. The assessment by capital-holders will be similar to your business analysis of potential companies to which you’ll be investing.

In most cases, procuring the capital is not going to be as simple as getting on the phone and calling up university endowments. Do you have an existing relationship or connection with such people? If not, going forward may ultimately be very difficult. And, as with anything, if you can convince them to invest in Fund I and you are successful, then Fund II will come knocking without too much effort. So, how to raise money for a venture capital fund, unless you know someone, I would suggest just doing a private placement on a deal-by-deal basis to accredited investors. It’s quite simply the easiest method to raise money in a very disciplined way. Would welcome any comments below. For information on what we’re building for the VC world, please visit http://venturecapitalist.org/

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.