The Fundraising Divide: How New VC Firms Secure Their First Funds
Securing the first fund is a critical milestone for any new venture capital (VC) firm. This process is often likened to a startup raising its initial round, with numerous challenges and hurdles along the way. This article explores the distinct attributes of raising the first fund and highlights key strategies and insights from experienced VCs.
Understanding the Challenges
When it comes to raising the first fund, new VCs face a unique set of challenges. Unlike experienced VCs who can leverage their reputation and track record to attract investors, new firms must build their credibility and value proposition from the ground up. Here are some of the main reasons why LPs are often wary of VCs:
Low Value Add
Most LPs and individual investors have experienced mediocre VC fund returns, especially when adjusted for risk and fees. A detailed report from the Kauffman Foundation highlights the necessity for institutional Limited Partners (LPs) to accept responsibility for the poor long-term returns from venture capital.
Liquidity Risk
Liquidity is a significant concern for VCs and startups alike. Unlike public markets, the VC world lacks the ease of liquidity. This means that LPs face long wait times to recoup their investments, while VCs and their general partners (GPs) collect their 2 and 20 fees, often without seeing their capital returned. This upfront commitment to the ecosystem can be a deterrent for potential LPs.
Agency Risk
The principal-agent problem in venture capital is another critical concern. Since VCs are not the investors' sole fund providers, their interests may not align with those of the LPs. This conflict of interest often leads to questions about the VCs' commitment and the sincerity of their goals. A decade or more of active investment is a significant undertaking, and ensuring that this investment is worthwhile can be challenging.
Strategies for Success
Despite the challenges, there are several strategies that new VCs can adopt to increase their chances of securing their first fund. Here are some key steps:
Step One - Identify Your Unique Value Proposition
The first step is to clearly articulate why your new VC firm stands out from the rest. Highlight any specific expertise, strategic partnerships, or unique value-add that sets you apart. LPs and individual investors are looking for evidence that you can provide value that traditional VCs cannot. This could include domain expertise, a unique network of connections, or a specific focus on niche markets.
Step Two - Secure an Anchor Investor
Getting the first investor is the hardest step, but once achieved, securing subsequent investors becomes easier. An anchor investor is typically a name-brand LP respected in the alternative investment space. It's crucial to secure this investor early, as they can provide validation and credibility to your efforts.
Step Three - Perfect Your Pitch
Your pitch should be clear, concise, and engaging. Use a manageable number of slides, anticipate questions, and be prepared to provide detailed answers through your appendix materials. It's essential to be flexible and adjust your pitch based on feedback. Additionally, maintaining open and frequent communication with your most supportive potential anchor investors can help keep them engaged and motivated to invest in your firm.
Key Insights from Experienced VCs
A valuable first-hand account of the challenges of VC fundraising comes from Alan Patricof, a veteran of the industry. In his career, Patricof has founded several successful firms, including Apax Partners. His experience underscores the importance of a clear value proposition and a well-planned pitch.
Getting the First Investment
According to Patricof, getting the first investor is incredibly challenging. Investors often prefer to have more than just one potential option, hence the importance of having a strong anchor investor. Once you have the anchor investor, it becomes easier to secure additional investments from other LPs. However, maintaining a strong pitch and addressing any concerns or questions effectively is crucial.
Conclusion
While the process of raising the first fund is indeed similar to that of a startup raising capital, it comes with its unique set of challenges. New VCs must focus on clearly defining their unique value proposition, securing an anchor investor, and refining their pitch. By understanding and addressing these challenges, new VCs can pave the way for a successful fundraising campaign and establish their credibility in the venture capital landscape.