How to Start a Venture Capital Fund

2 min read

Sep 27, 2022 9:52:14 AM | Assure

Wondering where to start when looking to start a Venture Capital Fund?

The venture capital (VC) sector in the United States is highly regarded as a driver of economic growth. Venture capital funds are crucial for supporting businesses as they are beginning to commercialize. The investment usually goes into building the infrastructure necessary for the realization of the concept. 

Here are a few facts on how to start a venture capital fund:

What Is a Venture Capital Fund?

Building a venture capital fund is a process of raising capital from several investors. The investors will then agree to advance some amounts through a limited partnership structure. The contributors of the fund act as the limited partners during the fund's cycle.

The general partners could be the leaders of the venture capital firm or a group of investment managers. The VC fund is often referred to as self-liquidating. That is because the general partners do not hold the fund. General partners have to immediately invest it and distribute any returns realized to investors when they exit.

Making the Fund Attractive to Investors

When setting up a VC fund, general partners should be conscious that the investors do not directly manage the fund. Therefore, efficiency is critical to reducing administrative costs. So they must limit their liability of the capital they have contributed.

Aspiring managers looking to start a VC fund must have a clear purpose. The clarity of the fund manager's goals and mission will help articulate their reasons for backing certain companies.

The fund's managers should demonstrate the viability of the project but also leave room for future investment. There may be provisions for investors to inject capital for other related innovations from the business during the fund's cycle.

The Innovation Cycle and Operations of VC Funds

A venture capital fund supports a company during its innovation cycle. Investors avoid the earliest stages when the business and its potential for success are still uncertain. The later stages of business growth are also unattractive to investors since there is a slower growth rate. The middle of the S-curve of the startup's evolution is usually the ideal target for fund managers.

We can think of the operations of the fund as a cycle. It begins with raising capital from investors, then putting that capital to work with investments into numerous assets (usually into startup companies) and ends with an exit that involves returning money to those investors. There will be a lot of value addition and monitoring during the operations of the VC funds. After the cycle concludes, the general partners can start a new fund.

How to Start a Venture Capital Fund

Due diligence is a critical function that investment managers must perform during the initial stages of the investment cycle. Since most startups do not have a track record of success, conventional methods of evaluating a business idea's viability are not practical. The typical VC fund manager has an extensive network of founders and uses many tactics to scout and vet potential companies for the fund to invest in.

One way to evaluate its viability is to mirror other innovations in the sector. The general manager may use forecasts from previous sales in high technology industries. The VC fund aims to find startups or later stage private companies with high growth rates and minimal risk.

Managing Risks During the VC Cycle

Some venture capitalists may invest in a startup with low growth rates. In such cases, the goal is to gain value from the business rather than focus solely on profits. The investor may be looking to boost their brand by associating with the startup.

However, most fund managers working on how to start a venture capital fund are keen on startups with high growth rates. A faster profit ensures that the investors can exit the fund sooner.

One way fund managers address ongoing risks is to monitor the process during the investment cycle. The most common source of conflict between investors and managers is the re-evaluation of capital infusion. Therefore, managers should be thorough at the initial stages to avoid disagreements later.

Striking a Deal with Entrepreneurs

Fund managers have to protect both the investors and the startups during the cycle of the fund. The investor may receive protection in the form of preferential equity. If the startup concept fails, the proceeds from the sale of its assets will prioritize the investor.

The deal can protect the startup using legal clauses that stop liquidation unless certain conditions are met. The contract ensures the business retains its equity, even when future valuation falls short.

Fund managers may use a special purpose vehicle (SPV) to co-invest along with their VC Fund when flexibility is desired. Also called Sidecars, SPVs are used by savvy fund managers to bring in additional investors that are not a part of the VC fund, make smaller investments in opportunities arise, or act quickly on pro-rata allocations when the startup raises additional capital in a later stage. 

If you want to start a venture capital fund, understanding the tasks and steps to set up and run a fund are crucial. Here at Assure, we can help you with this. You can take advantage of our VC fund administration for emerging fund managers to perform audits, conduct capital calls, and reconcile accounts. Begin your VC fund and SPV journey today!