Stumbling into the World of Venture Capital and How You Can Too

I've always been fascinated with the world of Venture Capital.

The thought of spending my days listening to startups pitch their ideas in the hopes of writing the first check into the next Facebook or Google sounds pretty great. The problem is, how does one even get into Venture Capital?

First, VC has historically been a very small and closed community with only a small number of top-tier funds. Those funds typically employ very few people, most of whom either come from very successful startups or a few prestigious universities. Unless you have an "in" from one of those paths, good luck.

Second, most top-tier VC firms have historically been located in just a handful of cities in the world, so if you're not in one of those locations, good luck.

Unfortunately for me, I didn't meet any of the above criteria, so I decided to start my own fund.

As I learned, there are good reasons for these barriers to entry - VC as an asset class is relatively small compared to other forms of investment, and within that, each year only a handful of investments create the big (e.g., 50X+) return that everyone is chasing. There just isn't room for hundreds of thousands of VCs out there... or is there?

One of the big trends within VC is the rise of "micro-funds" - small funds that are often created by 1 or a handful of people and invest in very early stage deals (e.g., seed or pre-seed rounds). Think of these funds much like an Angel investor, but instead of using their own money, they typically have outside investors known as Limited Partners (LPs).

Today there are more than 300 micro-funds, up from less than 100 just a few years ago, and the trend appears to be on the rise. While we can debate the pros/cons of more micro-funds entering the market, what the trend shows is that more people are simply starting their own small funds, and that is exactly what I did nearly 3 years ago. If I can do it, so can you.

I didn't necessarily set out to create a micro-fund from the start, but after countless hours of research and working through different options, I just ended up down that path.

But there's a catch with starting your own VC fund, it's complicated.

Let's break down the main drivers of the complication and tackle each one individually.

1. Unless you have lots of money, you need investors.

The whole point of a VC fund is to invest (mostly) other people's money and take part in the upside if you return a profit. The fund manager (General Partner, aka GP) is typically expected to put in 1-5% of the fund, depending on the size, to have some skin in the game, but outside investors typically make up 95-99% of the investment.

Okay, so how do you get outside investors? If you truly want to become a VC, you're going to need to have some strong investment points of view. In order to generate PoVs, you're going to have to do your homework... trust me, you likely won't get to see any good deals (aka "deal flow") unless you develop some relationships, and the best way to develop relationships is to develop knowledge in a particular subject that is relevant to the startup world.

The best way to do this is to SPECIALIZE. Pick one particular niche topic, ideally one that you are passionate about, and learn everything you can about that subject. Then start forming your PoVs on the subject and posting them on forums where you can develop some cred. Then research all the startups in your niche and start forming views on which ones you would want in your own VC portfolio. Then start posting those views from an investor perspective in a "mock portfolio" context... in other words, develop a bit of a pseudo-track record that can be tested empirically over time.

Yes, this takes time, I know, but is still probably your fastest path into VC.

Your goal here is to develop a corpus of information online about your niche so that when you start asking investors to back you as a VC, you have some history. If you can point back to some early stage companies that you identified that went on to raise successful A, B, C rounds down the road, that's going to seriously help.

Now let's assume you have some cred, now you need to actually find investors with actual $ to give you. Given your lack of experience, forget about any institutional funding (e.g., endowments, pensions, etc.) - they simply won't invest with you at this stage. Your only path is going to be through high-net worth (aka "accredited") investors.

Finding HNWs is going to also take time, so start this in parallel to developing your niche views. You need to put yourself in enough places to interact, both online and in person, with folks who invest in small companies. Then you need to build relationships over time. My advice is to offer to help them without any expectation of return... show them you have some skills and then when the time comes to ask for investment, you have already paved the way.

Let's be honest, doing the research as if you're already a VC and then networking with potential investors is no small task. This could take years and there is no guarantee you will get anywhere. That's what weeds out the talkers from the doers. The point is, there is a path and it is possible for nearly anyone.

2. Setting up an actual VC fund involves a lot of complex legal structures, and that's expensive.

It definitely CAN be complex and expensive, but it does NOT have to be. There are multiple ways to structure a fund depending on your domicile and preferences, and you will certainly need legal support, but there are ways to do this on the cheap if you're willing to put in some work.

First, you need to develop your fund entity structure. Most funds in the U.S. operate in a 2-entity model, with the fund managed out of a Limited Liability Company (LLC) by the GP, and the fund itself setup as a Limited Partnership (LP) which is owned by the LPs. You can set these up in Delaware by yourself for about $500 by downloading some forms and filling out paperwork.

In this setup, the most complicated documents you will need are your Limited Partnership Agreement (LPA) which dictates how the LLC will manage the LP, a Private Placement Memorandum (PPM) which is basically a prospectus, and the Subscription Agreement, which is the actual form your LPs will fill out to go along with the check. I am not a lawyer, and by no means is this an exhaustive list, but these 3 documents cover the core elements.

To get a sense for what each entail, just google the names and find some relevant examples. Next, find a lawyer who has experience in this area and let them know up front you want to do a lot of the work yourself and you're comfortable working from common templates. Chances are, you don't want to stray too far from the norm here so you likely won't need a lot of custom (e.g., expensive) modifications.

The next part, which is something I learned after I was already "pot committed" was the securities registration requirements. This is by far the most complicated and too long to get into here, but depending on where you setup your fund, there are various State (and possibly Federal) registrations you will need to go through. It's a learning process, so peel back the onion one step at a time, learn what you need to do, and work through it.

3. VC funds have lots of compliance and other admin requirements that are not fun to manage.

True.

As a small fund, you will spend an outsized amount of your time on fund admin tasks such as accounting, reporting, >compliance, etc. This is the entry fee to being a VC and every firm has to do it. The larger firms can outsource their backoffice >so they don't have to worry about it as much. If you're small and on a budget, chances are you will need to carry much of this >burden.

Sounds easy, right?

Well, if you've made it this far and you're still interested in starting your own VC fund, I do have a silver lining.

Thanks to new platforms like AngelList and their syndicate programs, you can be a VC and let them handle almost all the rest.

You will still need to find investment backers, but instead of finding a handful of people to write you larger checks to invest in the full fund, you only need enough to make each investment and the investors who back you can put in as little as $1,000 for each investment. That is MUCH easier than trying to convince a HNW to give you $100K.

AngelList will handle all the complicated entity structure and back-office stuff, although you will need to be prepared to go through some paperwork. The good news is this is much simpler.

If I were starting over today, rather than going through the trouble of putting together an actual fund, I would absolutely launch on AngelList. The amount of share (aka "carry") that you give up is well worth the hassle for all the complicated admin.

So in summary, here are the steps... 1) develop a thesis around what you want to invest in, 2) launch a syndicate on AL and get some backers, 3) find good startups and make investments.

I know that sounds simple and I'm understating a lot that goes into it, but the fact is that Venture Capital is transforming from a highly exclusive small club into an open platform that almost anyone can participate in. While there will certainly be some side effects that come as a result, it has opened the door for those who have a fascination with VC and want to get in just like me!