Venture Capital Managers Considerations for Business

Published: May 2, 2022
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In 2021, U.S. venture capital funds raised a record $128.3 billion across 730 funds.¹ eclipsing the 2020 record of $86.9 billion by a staggering 47.5%. This was matched by a record-breaking year for VC-backed companies exiting with approximately $774.1 billion in exit value through public listings or acquisitions, a whopping 168% increase over 2020.

Few expected 2022 to match this growth. The first quarter of 2022 has seen volatile market conditions across nearly all sectors, including venture capital. The unexpected war in Ukraine continues and interest rates have finally been hiked, resulting in less readily available capital.

Q1 saw total venture funding hit $160 billion, a decline of more than 13% from the final quarter of 2021 but still up on Q1 of 2021. There was also a decline of 8% versus Q1 of 2021 on U.S. venture deal value and a 26% decline versus Q4 of 2021. With a wider trend of poor public market performance for growth assets, there was almost a complete halt in IPOs of VC-backed startups.

Although private markets often lag behind public markets in a downturn, the consensus is that emerging VC funds will find it harder to raise capital versus recent years. With that in mind, it is important for managers to build a robust business that helps them stand out in a more competitive market. There are several ways to do this.

Checking the Operational Due Diligence (ODD) Box:

With an abundance of venture capital funds for limited partners (LPs) to choose from, it is important for funds to partner with reputable service providers. There are typically four service provider groups the LP community will scrutinize:
- Law Firms: There are a handful of law firms that specialize in venture capital fund formation. When picking a law firm, make sure that you are working with both a firm and a team that have vast experience in the mechanics of VC fund formation. Investors will look at your private placement memorandum (PPM) and will expect certain language that VC fund formation specialists will provide.
- Banks: First Republic Bank and Silicon Valley Bank are the two banks that have a large market share in the VC space. If you decide to go with a bank with less experience, be ready to explain your decision to your LPs.
- Fund Administrators: Fund administration is a congested space and can be daunting to navigate. There are a group of approximately a half dozen fund administrators who specialize in the venture capital space. These firms are a good place to start. Choosing a fund administrator that does not specialize in the venture capital space can be a red flag for LPs and can lead to difficulties further down the road.
- Audit and Tax Providers: LPs will want to see a known name with vast experience. Larger funds will want to look at one of the eight larger firms in the fund space, but there are also regional alternatives for smaller funds. Audit and tax are typically packaged together. On the tax side it is important to ensure that your tax team works with a good number of venture capital funds.

Marketing Deck:

In the current market, LPs have the luxury of choice when allocating their assets. One way for funds to differentiate themselves is to spend time and resources on their marketing deck. There are several firms that specialize in creating a unique deck that will clearly explain a fund’s differentiation points and story. One common mistake first time fund managers make is overcomplicating the message. This can be on any number of items including fee structure, investment approach, timeline, etc. When creating a deck, managers should lean on their service providers and peers to ensure that what they are building is in line with LP expectations.

Investment Focus:

It’s key for funds to identify their investment strategy and articulate this in a concise and consistent way when interacting with potential LPs. Will the fund be generalist focused or will it focus on a specific sector? How many investments will the fund make? What is the timeline of the fund? Will the fund be taking minority or majority positions? How many closes will the fund have? Is there a timeline for Fund II? What is the fee structure? These are all questions that investors will want to understand. The goal here is to strike a balance between standing out from a congested crowd and making sure the fund’s structure and goal are easily understandable.

Launching Fund II and Beyond

For managers who are further down the road and are in the process of contemplating a Fund II or III, the ultimate goal is to grow assets while ideally increasing the ticket size. As a fund begins to target more institutional investors, it is important to revisit the service provider group and ensure that each of them checks the ODD box. Also, for firms that have had a successful previous fund(s), it is important to not deviate too far from the original investment strategy (unless there is a specific reason to do so).

^{1 https://www.reuters.com/business/finance/us-venture-capital-deals-notched-all-time-high-330-billion-2021-2022-01-14/}