Three things surprised me most about venture capital:
- Legally, anybody can be a venture capitalist.
- It’s the only asset class in which the asset picks the manager.
- Raising a fund is like a Walk-a-Thon: People pledge you money, you do the hard work, run, and THEN you collect the money and give it to someone else who can make an impact in your life.
Anybody Can Be a VC
Perhaps the biggest open secret in venture capital is that anybody can be a VC. With minor exceptions (e.g., underage, certain felons, bad actors), legally anybody can be a venture capital fund manager. VCs don’t need to be licensed or even accredited investors to issue interests out of their own fund.
And yet, it takes longer than a year for new fund managers to successfully raise a venture capital fund and a total of 16 months for female managers. Only 13% of venture capitalist firms even have a female partner. Underrepresented women are represented at 0.67% for black women and 3.22% for Latinx women. These statistics are all pre-Covid-19.
So if anybody can become a venture capitalist, why do these numbers look so skewed?
One venture capitalist expressed the matter this way:
“Venture Capital is a capacity constrained industry.”—Kanyi Maqubela, GP at Kindred Ventures
In other words, all venture capital is sourced from a select group of capital allocators—LPs—including family offices, pension funds, university endowments, and other high net worth individuals. New VCs are often sourced by already existing VCs.
LPs understand that venture capital is patient capital. It takes 10 years or longer to successfully operate a venture fund from start to finish. A VC can make 50+ investment decisions over a decade or longer. Rather than pick new fund managers every year, LPs invest a lot of time before making a decision on a new emerging fund manager.
According to Preqin, there are over 1,000 venture firms actively raising in the market right now. Only a fraction of the hopeful managers will be picked by LPs to join the VC ranks. What happens to the rest of the aspiring VCs?
What if, as Paige Doherty recently tweeted, there’s another way into VC—i.e., what about “crawl[ing] through a window“?
last year, a founder told me that there were two main ways to get into VC:— paige (@paigefinnn) July 23, 2020
1. be an entrepreneur and have a successful exit.
2. go to harvard/stanford, do investment banking, then private equity, then VC.
he paused and said, there’s one more option:
crawl through a window.
Every aspiring VC wants to know: What does it cost to form a fund and what does it take to start crawling through that window?
Two options for forming a new venture capital fund:
- Hire a Law Firm—$50K to $250K.
- Third Party Service Provider—$5K-10K+ 1.5%-5% of the offering
On average, it costs $222,000 to form a venture capital fund. Legal fees alone can range anywhere between $50,000 and $250,000, and even higher if using a top tier law firm.
Several new technology platforms have emerged to help new fund managers. Here’s a partial list of potential third party service providers offering low cost, high volume fund formation services:
- AngelList Syndicates & Rolling Venture Funds
- Assure Management Co.
- Carta SPV Formation
If you plan on accepting institutional LPs, you should expect to hire a big law firm. But for those looking to fit in the crawl space, LPs may not be as demanding about who your legal counsel needs to be, so long as the documents and representation meet or exceed expectations.
- So, what’s the best way to start a Venture Capital Fund?
Although there are no rules of regulation or licenses required to be a VC, some duties are imposed by contract or state law, such as the limitations on certain investors (for example, AngelList will not let non-accredited investors setup a syndicate without qualifying as an accredited investor).
- To qualify as a venture capital fund, the general partners (VCs) of a venture fund simply need to state that the fund will pursue a “venture capital strategy.” That’s generally it. VCs are allowed to invest in startups with at least 80% in equity-based bets. But VCs are also limited in how much debt they can lend out and how much “non-qualifying” assets they can acquire, such as digital assets or crypto.
- VCs will also have to prepare additional forms (e.g., Form ADV for Exempt Reporting Advisers) and file certain disclosure documents (Form Ds & Blue Sky filings). But these filings are all administrative in nature and not reviewed or approved by any government agency or third party.
- Venture capital investments have traditionally been formed as limited partnerships, but these are increasingly being structured as series LLCs or Series LPs. AngelList and Assure are embracing these new types of entity structures, which create new and interesting opportunities on how VC funds will operate now.
- The most common legal requirements of a venture fund are often around the regulatory issues of a fund’s investors.
- For example, each fund is limited to the number of investors that can join based on their investor suitability—all investors must at least be considered “accredited investors,” which means a net worth of $1 million excluding the value of their home or $200K+ per year of income. Venture funds over $10 million are limited to 100 investors, while funds under $10 million are limited to 250 investors. There are a lot of other rules and regulations that limit the type and number of investors, but those are the key ones.
There are generally two types of venture capitalists (VCs):
- #1) PLATFORM FUND MANAGERS (25-50 funds): These fund managers tend to run larger groups of venture capital team members who operate at scale. They’re more likely to have qualified purchasers only in their fund. Most platform VCs are magnets to accumulated management fees. Two venture funds with good records are a16z and First Round Capital.
- #2) VC SPECIALISTS (1,000+ VC funds): A manager’s investment thesis is the strategy for investing in a narrow band of stage, size, geography or industry focus in their portfolio. But to a certain extent, “your fund size is your strategy.” Most firms operate in Seed stage under Section 3(c)(1) of the Investment Company Act—where 67% of Fund I offerings were from family offices and high net worth individuals (53% for Fund II, and just under 50% for Fund III’s). See Samir Kaji’s report on Micro VC Fundraising.
Option 1: If you are or plan to be a platform fund manager, you don’t have much of a choice: Your LPs will demand a big law firm name to close your fund documents. A big law firm will charge you accordingly.
Option 2: If you are a Specialist VC or Solo Capitalist looking for a more effective cost solution, you should consider retaining a third party service or contacting a VC fund attorney to represent your fund. Here’s a short list of law firms and attorneys who handle VC fund formations:
- Harvey Esquire – Venture Capital Lawyers – My firm – 310.819.1366
- Acceleron Law Group – Andrea Cohen – 415.425.9646
- Fund Law Group – Jeremy Neilson + Michael Blackham – 385.297.8048
Option 3: If you are an active investor such as a venture scout, angel investor, manager of an operator angel fund, a syndicate lead or a non-traditional manager, you are in the crawl space, and you might consider using a third party service such as the ones referenced above under Costs.
Hopefully, this article helps inform when you should use a law firm or look at a third party service, and what steps you should take to start the process.