For years – even decades – there was little question of whether you could become a venture capitalist if you weren't comfortable financially. You couldn't. The people and institutions that invest in venture funds want to know that fund managers have their own “skin in the game”. Hence, they have long required a sizable check out of the investor's own pocket before going on board. Think of 2% to 3% of the total assets of the fund, which is often the equivalent of millions of dollars.
In fact, I wrote five years ago that the real obstacle to becoming a venture capitalist had less to do with gender than financial inequality. I then focused on women who are paid less (especially black and Hispanic women) and who are less wealthy. However, the same applies to people with fewer resources.
PsLPs: The ≧ 1% of a fund's expected capital commitment by GPs makes it difficult for POCs to raise funds.
Remember that "for a $ 20 million fund, a 2% commitment with 2 GPs is still a $ 200,000 commitment for each partner". This is out of reach for many of us. https://t.co/bguXpa3CiY
– lolitataub (@lolitataub) October 29, 2020
Thankfully, things are changing, and there are more ways to help aspiring VCs increase that initial capital lockup. Neither of these approaches can guarantee success in raising a fund, but they are avenues that other VCs have used effectively in the past to get started.
1.) Find investors, i. H. Limited partners who are willing to take on less than 3% and possibly even less than 1% of the target total fund size. You are likely to find fewer investors as this "commit" shrinks. But for example Joanna Rupp, The person who manages the $ 1.1 billion private equity portfolio for the University of Chicago Foundation suggests that both she and other managers she knows are ready to go on the foundation to be flexible to the “specific situation of the family doctor”.
Rupp says: "I think there are industry standards, but we have not asked younger general practitioners (complementary) commitments if we have the feeling that they do not have the financial means."
Bob Raynard, founder of the fund management company Standish Management, agrees, saying that less involvement by the general partner in exchange for special investor economics is also common. "You may see a reduced administrative fee for the LP to help them, or a reduced carry, or both, and have been for years."
2.) Examine the compensation payments for management fees that venture fund investors often find reasonable. That's not unusual, says Michael Kim by Cendana Capital, a company that has interests in dozens of seed stage funds because they also offer tax breaks (though the IRS has talked about getting rid of them).
How do they work? For example, suppose your commit was $ 1 million over 10 years (the standard term of a fund). Instead of trying to make $ 1 million that you probably don't have, you can offset up to 80% of it by wagering $ 200,000 instead, but lowering your management fees by the same amount over time, so that it's a wash and you & # 39; I still get credit for the entire $ 1 million. They basically convert fee income into the investment you're supposed to make.
3.) Use your existing portfolio companies as collateral. Kim had at least two highly respected managers set up a fund, not with a “commit” but by bringing holdings to startups that they had financed as angel investors.
In both cases, it was a huge deal for Kim, who says the companies were tagged quickly. For the fund managers this meant that they no longer had to put their own money into the funds.
4.) Make a deal with richer friends if you can. When Kim launched his Fund of Funds to invest in risk managers after working as a VC himself for years, he raised $ 1 million in working capital from six friends to get it off the ground. The money gave Kim, who was on a mortgage at the time, and small children enough runway for two years. Of course, your friends need to be willing to gamble on you, but sweeteners certainly help too. In Kim's case, he was giving his friends a permanent percentage of Cendana's economy.
5.) Get a bank loan. Rupp said she would be uncomfortable if a general practitioner were to finance his commitment through a bank loan for several reasons. There is no guarantee that a fund manager will make money from a fund. A loan increases the risk in addition to the risk. Should a manager need liquidity related to this loan, he or she may sell a strong performing position too early.
However, credit is not uncommon, says Raynard. He says that venture capital banks like Silicon Valley Bank and First Republic are usually happy to provide a line of credit to a fund manager to help him or her make capital calls, though he says it depends on who else is in the fund is involved. "As long as it is a diverse group of LPs," suggest the banks to attract the business of a new fund.
6.) Take a look at the advantages of so-called frontloading. This is a technique that "more creative LPs can sometimes be comfortable with," says Kim. This is how the now multi-billion dollar investor Chris Sacca began when he turned to fund management for the first time. How does it work? Some beginning managers mix their annual management fee of 2.5% of assets under management and pay a higher percentage – say 5% for each of the first three years – until the manager doesn't get a management fee from everything at the end of the fund's life.
This could mean no income if you are not yet seeing any gains from your investments. As the general partner, you have presumably set up another fund up to this point – especially in view of the pace in recent years – so that resources from a second fund have been received.
These are just a few of the ways to get started. There are other ways too, notes Lo Toney by Plexo Capital – which, like Cendana Capital, is involved in many venture funds. One of them is using a self-directed IRA to fund this GP commit. Another option is to sell some of the management company or a larger percentage of your carry and use that proceeds to pay your commit. (VCs Charles Hudson of Precursor Ventures and Eva Ho of Fika Ventures have avoided this avenue and suggested that first-time managers do the same when they can.)
Anyway, says Toney, a former partner of Alphabet & # 39; s Venture Arm, GV, it is important to remember that there is no right way to raise a fund, and there is no disadvantage to these strategies of raising funds to use a fund. Toney said via email this week, "I haven't seen any data on the front end of a VC's career that says wealth indicates future success."