How to Set Up a Venture Capital Fund (2024)

Are you an aspiring first-time manager interested in setting up a VC firm and raising a fund? Do you think you have the insight and skills to find promising early-stage companies to achieve a “venture rate of return” of at least 3X? Then you’ll first need to establish a management company responsible for managing the VC firm’s operations before raising capital for your VC fund and begin writing checks.

Before diving in, let’s agree on a definition of a VC fund. Venture capital is a subset of private equity where a pooled investment fund raises capital from multiple investors (limited partners) to source investment opportunities in private early-stage startup companies with high growth potential in exchange for equity in the company. The goal is to make a profit for investors when the company exists through an IPO, merger, or acquisition.

The venture capitalists or general partners (GPs) are invested in the fund and typically play active roles in their portfolio companies, including serving on boards, providing strategic advice, making introductions, and helping obtain additional financing.

Fund sizes vary from a few million dollars ($5-$15 MM) for pre-seed investments to several hundred million for later-stage growth funds backed by institutional investors.

Setting up a fund may vary depending on the stage the fund would like to invest in, the sector or industry, and the performance objectives for its portfolio companies. Full-time GPs typically require between $20 MM and $40 MM per head in fund size to cover salaries and expenses, assuming a 2% management fee.

This article will help emerging fund managers understand the VC business model, set up the management company, and raise capital for their venture capital fund.

Build a Track Record or Have a Competitive Advantage

You’ll have a tough time finding limited partners willing to invest their money if you don’t have a track record of successful investing.

So before launching a VC fund, it’s crucial to spend some time in the venture capital ecosystem or investing your own money as an angel investor, giving you the chance to learn the processes and how to provide value for your LPs and portfolio companies. This is also where you’ll develop your network. Connections are critical in venture capitalism. There’s no point in starting a VC fund unless you are exceptionally well-connected.

If you are an operator (former entrepreneur, executive or subject matter expert) who can provide hands-on guidance and leverage your professional networks to fundraise and help early-stage founders, we recommend you partner with a “financial” VC or someone with a track record of putting institutional capital to work.

In some cases, a VC without a “brand” works with one who has a personal audience such as a large LinkedIn following. You might have money, but you need someone with knowledge and connections or the other way around. The point is that it’s often wise to find a partner to start your VC fund that brings a complementary skill or experience to the firm.

As a General Partner, you are expected to “have skin in the game” by contributing to your fund, ensuring you and your partners have a strong interest in the fund’s success. On average, GPs contribute around 2-5% of the fund’s total size with their own money.

If you are trying to raise $50MM for your new fund, you and your partners should personally contribute between $1MM and $2.5MM. If you and your partners are not high net worth individuals and don’t have the liquidity to write those initial checks, there are still multiple waysto launch your venture capital firm.

Define Your Investment Thesis

The venture capital industry is small, tight-knit, and very competitive. To convince LPs and potential companies to take you seriously, you’ll need to bring something new to the table regarding your investing strategy. Developing an investment thesis helps you define your brand and functions as a key resource in fundraising for your fund.

To develop a compelling investment thesis, you and your partners must meet with potential LPs, including family offices, endowments, high net worth individuals, pension funds, advisors, etc.

As you form your fund and start raising capital, you will be iterating and refining your thesis. Your investment thesis will be largely influenced by the feedback you receive while starting your venture firm, conducting research and raising your first fund.

We recommend you write down your investment thesis by following the format below:

(Fund Name) is launching a ($xMM) (stage) venture fund in (location) to back (geography) (sector/Market Companies) with (secret sauce).
For Example:
Gem Ventures is launching a $100MM Seed Stage and Series A fund in New York to back East Coast Fintech companies sourced from the partner’s network built while working at the corporate innovation department of a big national bank.

For instance, when Rajat Bhageria and Nandeet Mehta founded their first venture fund, Prototype Capital, they had very little capital, so they needed a way todifferentiate themselves from other VCs: They hypothesized that traditional industries like healthcare, transportation, consumer packaged goods, and manufacturing would experience transformation soon, but those people aren’t holed-up in Silicon Valley. Their differentiator was their scout network, which could find founders all over the country that other VCs aren’t even paying attention to.

Investing Decision Making

How are you going to make investment decisions? What factors will go into determining company valuations? Will you be investing the same amount of capital into each company? Will you be making follow-on investments? Ideally, it would help if you had given thought to all these questions before formally starting conversations with limited partners.

As an emerging manager investing in early-stage private companies, you need to be adept at measuring, evaluating, and minimizing risk while producing significant returns from your investments. This is both an art and a science and a key to your success as an investor.

Establish Your Venture Capital Firm

As an emerging manager, you will spend most of your time and energy raising capital for your fund, yet setting up your firm, legal entities, and all the back-office processes is imperative for the success of your fund.

Generally, venture capital funds are structured as limited partnerships. Limited partners supply the money, and the general partner manages it. Typically the general partner operates within a management company that exists as a separate legal entity from the fund. It’s essential to establish this legal entity before you start raising money and scheduling meetings with potential portfolio companies.

When it comes to setting up the limited partnership agreement (LPA), the devil is in the details, especially those areas that pose a significant risk, including the fees (management fees, carry, incentive fees, etc.).

Having a good understanding of these fees is crucial since this can ultimately affect the performance of the fund and, therefore, the performance for the LPs. As an emerging manager, you should also hire a trusted accounting partner with experience in venture capital to ensure the fund structuring is tax-efficient, work with you during audits and through the lifecycle of your fund.

Setting up an LPA and establishing the LLC is not one of those tasks you can manage yourself. It’s best to find a competent lawyer to set up these legal entities for you to ensure that everyone is protected. The legal costs of setting up a VC fund can range from $30,000 to over $200,000, depending on several variables.
Similar to other businesses, emerging managers should take into account operational aspects such as:

• Personnel and staffing
• Cybersecurity and data protection
• Compliance and regulatory
• Selection of professional service providers
• Office space, travel, and other logistics
• Software platforms and technologies

To understand the multiple steps required to set up your venture capital firm, readthis guidefrom BDO.

Defining a Due Diligence Process

By definition, venture capital investments in new businesses are risky, so due diligence is a necessary part of running a fund. Since proper DD can be time-consuming and tedious, you’ll need to establish a process.

Typically, for every 100 companies reviewed, 10 will receive a detailed review or go through the due diligence process, and the fund will invest in one of them.
Every firm approaches due diligence differently, and every potential investment calls for a different approach; however, most investigation tends to fall across these categories: management team, market, product, traction, legal, and financials.

To be effective during this process, you must establish a workflow to collect and evaluate this information. You may do the research yourself, hire an assistant to put reports together or outsource to another agency. You’ll need these reports for any company you consider, so design a process that doesn’t take up too much of your time.

To learn more about venture capital due diligence, readthis guide.

Selecting the Ideal Venture Capital Tech Stack

As a GP, you will most likely not have the budget to hire multiple employees when launching your first fund. However, you will be very busy fundraising, sourcing, analyzing, investing, and supporting your portfolio companies.

Adopting the righttechnology stack is crucial to increasing your productivity and the fund’s chances of success. At a bare minimum, we recommend getting subscriptions toPitchbookandCrunchbaseto access the data you need when evaluating potential deals.

As far as software, you should adopt a CRM system to automate, optimize and standardize the deal-making process. However, not all CRMs are created equal. Most transactional CRMs, such as Salesforce, are designed for sales teams focused on closing transactions, NOT managing sophisticated venture capital deals.
Investing in early-stage ventures is very different than selling a product.

Emerging managers should look for a CRM that understands your firm’s workflows and nuances.
At4Degrees, venture capital is in our DNA. Our founders are former VC investors looking to change the relationship between venture capital and CRM by creating a system designed to address their specific pain points.

We built our venture capital CRM for busy investors who want to leverage the power of their networks to access high-quality deal flow and improve their ability to find and execute deals while also managing their portfolios and internal processes.

4Degreesautomatically captures an investor’s email communications, meetings, and contact information and analyzes these data points to help VC teams find the proper connection and best path to a warm introduction that can result in a deal.

Going Forward

We’ve given you a high-level overview of what it takes to set up a venture capital fund, but you will inevitably encounter challenges and obstacles. We recommend finding an advisor or attorney to walk you through the process. If you establish your fund properly, you will be able to devote all of your attention to raising money and finding great portfolio companies.