Note: This article is the seventh in an ongoing series on venture fund formation and management. To learn more about managing a fund, download this free eBook today Venture Capital: A Practical Guide or purchase a hard copy desk reference at Amazon.com.
Venture Capital is one of those professions that is idealized by many and misunderstood by most. From a distance it seems like it should be great. You are your own boss, you set your own hours, you are not stuck behind a desk, you hang around with interesting go-getters and you sling big piles of cash around. What could be better?
Venture Capital is extensively written about by the business press, discussed in depth by entrepreneurs, and seen as an excellent career choice by MBA students at top business schools all over the world. Many VCs who write, tweet and give interviews end up attaining minor celebrity-level status along the lines of professional athletes and movie stars.
And if you strike it big with an investment in a company that has a billion dollar exit, you can be looking at a major payday that will set you up for life. With that in mind, it’s not a big surprise that many entrepreneurs and finance professionals look to a career in venture capital as a way to make big bucks and live a charmed life. If only it were so easy!
So...you still think you want to run a venture fund? Maybe it’s a good idea to take a look at the reality. What are you actually getting yourself into?
Let’s take a close look at some of the issues and challenges you will face in building a successful venture fund. In a previous article, we discussed the obstacles you may encounter in raising capital for your fund. That hurdle alone will stop most individuals from getting established as VCs. You would think with new venture funds popping up everywhere, it must be pretty easy to get a fund up and running. Although we don’t have any hard data we can point to, based on what we have seen in the market, it wouldn’t surprise us if less than 20% of those teams who set out to raise a venture fund actually succeed in raising the fund. And the ones who fail, put in a fair amount of unpaid work and travel before they ultimately give up.
Before we jump into a series of questions on the key challenges faced by VCs, let’s set some context. This discussion is centered on smaller funds. By that we mean our answers will focus on challenges faced by small venture funds that raise under $100M. At the dawn of venture capital, that was a decent sized VC fund. In today’s market that is small, and this size class is where the majority of new Seed Funds, Angel Funds and Social Impact Funds would fall. Some of the answers below will also apply to Corporate and Government Funds, but their challenges are often dictated less by the responsibility of generating large financial returns and more by the long term goals and politics of the specific company or government.
Ham, outside of the fundraising challenge, what are some of the biggest challenges a General Partner at a venture fund runs into?
When I look back on the past 20 years as an active early stage investor, the biggest challenge I face is not having enough time to cover all the bases. Even if you work hard and put in long hours, it is very easy to have something boil over somewhere. If you are a GP in a small fund, your responsibilities are wide ranging and very time consuming. They include the following (and more):
Screening your deal flow looking for interesting companies
Meeting with entrepreneurs to evaluate whether to invest in their company
Performing diligence, negotiating and syndicating deals, and closing investments into new companies
Helping your portfolio companies succeed as a board member or advisor
Meeting with and reporting out to your Limited Partners (LPs)
Networking, networking, networking (you have to get your name out there and keep it out there!)
Reams and reams of communications in support of everything above; in early stage investing, you better like doing lots of email, phone calls and text messages, because they will form the backdrop to everything you do, and frequently extend well outside of normal business hours.
At first glance, that list of tasks doesn’t sound too daunting, until you dig into each one and learn what it really takes. Each task can take dozens of hours per week if you don’t do a good job with time management. And, first time VCs who don’t have experienced partners in the fund will usually struggle with balancing all that’s on their plate.
How do you handle the challenge of managing deal flow and meeting with lots of early stage companies?
Screening your deal flow looking for interesting companies doesn’t sound too difficult. In fact, it sounds pretty exciting. Who wouldn’t want to evaluate cool startup companies by sitting down for a 30-60 minute coffee with some really interesting entrepreneurs? That sounds like fun to me, and it was when I first started out investing.
Let’s take a look at the math behind how much time it takes for this task. A VC with a good network receives hundreds of plans a year. Each one takes a few minutes to screen to see whether it’s a fit for the fund. Out of the hundreds of plans you receive in a month, maybe 10% of the plans are worth having a meeting with the company. So, 20 meetings times 30-60 minutes per meeting adds up to 10-20 hours a month. That sounds manageable… but that’s not how it really works. Scheduling the meeting, travel time to the meeting, and a variety of other factors can easily extend that 30-60 minute meeting into well over an hour of real time spent. And, don’t forget the demo days you attend during the month to see a quick, concentrated set of pitches from 10 or more companies. Those demo days can easily take up half a day of your time.
Don’t get me wrong… I still enjoy meeting new entrepreneurs and hearing their pitches. These days, in order to manage my schedule efficiently, I have to be a bit more selective in the number of meetings I take. For first time venture funds, having very well-defined criteria for choosing companies is important to limit the amount of time you waste looking at plans that don’t fit your firm’s investment criteria. It’s not unusual for a VC to invest in only 1 out of every 100 deals that cross their desk, so an efficient process is required. And, coming up with an efficient approach to scheduling and getting to meetings will save you a ton of unproductive time. Some investors will use scheduling tools in their emails, some will try to get entrepreneurs to come to them to save travel time, some will fall back to phone calls or video calls in lieu of a portion of their meetings, some will hold “office hours” where they just set aside a block of time and bang through a bunch of sessions, and some, like my crazy partner Christopher, will resort to inviting an entrepreneur to walk or ride the subway with him in between meetings!
In Part II of this article we'll take a closer look at the time commitment when you find a company you want to invest in, what's involved in serving as a board director, and how GPs should handle communications with their LPs.