Raising VC money: which VCs to target?

This is the first post in a Friday series on “raising VC money”.  For the list of topics we are covering, click here.

In this post, we’ll focus on the first topic: which VCs to target?  I think it’s a critical step in the fundraising process.  You have a new business idea, you’ve spent a ton of time on a presentation, and you already know that random spam-email to VCs won’t get you anywhere.

So, what should you do?

This sounds obvious, but you should raise money from people who can and want to give you money.  There are a few implications to this.

First, understand if a VC firm can or cannot invest.  A VC fund contractually lasts 10 years, but there’s a very important legal term called “the investment period.”  This is the time period during which a VC fund can invest in new companies.  After that period ends, a VC cannot.  A VC can invest in follow-on rounds in companies that already exist in the portfolio, but he/she cannot invest in a new project once the investment period expires.

Investment periods are almost never longer than five years long.  Moreover, most firms “fully commit” a fund in about three years (more below).  After that, they have to raise a new fund to invest in new companies.

Second, an entrepreneur should target a “Goldilocks” VC who knows your space–but isn’t jaded by it.  VC firms encourage their partners to specialize.  It is simply better for the firm if one partner focused on Consumer Internet, another looked at Clean Tech, a different one evaluated Big Data, etc.  Divide and conquer.

So, you definitely want a VC that is up to speed on your space and has the contacts to help.  But, here’s the key: VCs often get jaded.  For example, in the Internet advertising space, some VCs have made so many investments in that sector, that they feel pretty full already.

On the other hand, if a VC has never made an investment in your space, you then have two sales cycles to manage.  You have to sell them on the sector, and you then have to sell them on your company.  That’s a lot to do.

Ultimately, you want the “Goldilocks” VC.  Someone who is expert, but still has the capacity to make more investments in your space.  You want that golden median.

Third, an entrepreneur should target a VC who has power and time.  Working with a junior VC can be very rewarding, but tricky.  That’s because someone new to the business, even if he has the “partner” title, will be given a very short leash by his partners.  So, ultimately, there’s a decision-maker in the background who has to sign off, which can complicate the dynamic.  A senior partner who has power within the partnership can get your idea funded much more quickly, and if you hit a bump, can shepherd through a follow-on financing when you need it most (for more on how VCs get paid, and how power is distributed at VC firms, click here).

Unfortunately, as a start-up’s time-to-exit has increased over the years (and as VC funds grew dramatically), many VCs are on many Boards.  Moreover, with rising VC turnover as partners switch firms or start new ones, the remaining partners inherit the Board seats, which makes the Board seat load even more acute.

In addition, the workload may be particularly severe for the most senior partners.  First, they normally handle the fundraising and communication with their investors (which is a huge amount of time), and second, those partners’ roles may have changed.  They may have gone from being VCs to a general manager of other VCs.

Regarding the latter point, if a firm is very large, the senior partner is keeping tabs on his partners’ decisions.  Moreover, if that firm has an extension fund (e.g., an India fund, a China fund, or a growth equity fund), a senior partner manages that one, too.  So, the most experienced VCs often have the busiest schedules.  As a result, some senior partners rarely make investments.

Given this reality, there are three pieces of advice I’d offer to entrepreneurs.

Advice #1: find out that VC firm’s last fund closing date.  New funds are announced and it’s easy to search for the old announcements.  If a VC’s last fund closed more than four years ago, just “be aware.”  If you can, ask the VC what percentage of the fund they have invested and what percentage is reserved for existing companies.

Each quarter or so, most venture firms engage in a “reserves management” exercise.  They look at each company one at a time and put in an estimate as to how much future capital may be needed for the company, which they then “reserve” or set aside.

Knowing this total number is important.  For example, let’s say that a firm has invested about 30% of its fund in companies.  In addition, they have reserved an additional 60% of the fund for future financings in those companies.  In total, that fund is now 90% “committed.”  It means that they have only 10% of the fund available for new companies.  That’s critical to know.

Also, a fund nearing the end of its investment period may be less open to a very early stage investment.  Since a fund’s life (and fee stream) is 10 years, a VC has an incentive to both invest and exit from its companies in that 10-year period.  A VC can get extensions from investors, but this requires a legal vote that takes time and effort.

If a company these days takes seven years or so from inception to exit, then investing in a seed project in year five of a fund’s life is possible.  But, this company is likely to bump up against the 10-year window.  So, a seed-stage company should just be aware of this.  I don’t think it is a major issue, but again, like with many long-term relationships, an open dialogue is important.

Advice #2: focus on individual VCs, not the firm.  Based on what someone blogs about, or on which panels they appear, you can get a sense for the spaces an individual VC targets.  Moreover, if you look at which Boards they sit on already, you can get a sense for their capacity utilization.  If that person is already on 10 Internet advertising Boards, will you be able to be the 11th?  It is possible, but just be aware.

Advice #3: target the most senior partner possible, but be prepared to be very efficient with your communication style.  Let’s face it: the senior partners have the power to get things done for you.  Also, in venture capital, experience really counts for a lot and there’s no substitute for someone who has worked with many companies.  You want an experienced VC on your Board, and VC is a difficult business to learn.  It’s a common data point among VCs (and the savviest institutional investors in venture funds) that it takes five years in the business before you really know what you’re doing.

Now, if the senior partner really likes your idea, but doesn’t have time to be on your Board, he will “pass you on” to another partner in his firm.  That’s still a good outcome.  The senior partner has “signed off” on your idea as a starting point, and that’s a great champion to have in the background.  Now, you will still have to convince this other and less-senior partner, but you are on your way: you’re now meeting with a partner who has power and time.

The complication about this advice is that VCs are busy.  You have a short list of VCs, but how do you get the meeting?  We’ll talk more about this in next Friday’s blog post. We’ll cover “how to get the VC meeting.”

4 thoughts on “Raising VC money: which VCs to target?

  1. Joe,

    Another great post, thanks again. I am interested in your next post on “How to get a meeting”. Couple of follow-up questions:

    1. How can one do their due diligence on where in the investment period a VC fund is? Can you find that information right on the website?

    2. What if you’ve identified VC’s within your particular space, and they have an investment or two already in that space (we spoke to each other a bit about this a couple weeks ago)? For example, if you are a VC and you invested in Facebook, you probably would not want to invest in MySpace, but you would still maybe want to invest in Linkedin. Why? They are all in the social media space, but Linkedin is greatly differentiated from FB, while MySpace may not be. Long story short, do VC’s look at one investment per industry, even though there may be differentiated opportunities in that industry? Sorry for the long comment!

    1. 1: If you Google around, you’ll find the old press releases

      2: It varies by firm. Some firms will fund competitors, most will not. It’s usually a judgment call. Ideally, both sets of founders are OK with it before the VC invests.

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