The more you understand about your VCs the better decision you can make. Obviously there are diminishing returns on how much time you spent analyzing versus executing, but my experience as both an entrepreneur and now an investor is taking a few minutes to apply this practical guide below is absolutely worth it.
1) Naming — At the start of the modern VC industry in the 1950s, there were no VC-specific conventions around naming a firm. Many of the older VC firms pay homage to their founder partners (e.g., Kleiner Perkins) or to ideas around innovation (e.g., New Enterprise Associates). Nowadays, notwithstanding ever-evolving norms, there are certain patterns and we will focus on two specifically:
- Ventures — You would think that word in a company’s title means they are venture capitalists. Caveat emptor: several firms, especially those trying to get business from startups, brand themselves as Venture something. Look them up, whether it’s their website, or a freemium site like Crunchbase or Pitchbook, or their SEC filing. If there isn’t a portfolio of companies they have invested in, chances are they are not a true VC fund.
- Capital — This implies the investor is focused on larger, growth rounds. But it’s not a 100% rule i.e., not all investors with the word capital are late-stage. Case in point, arguably the most famous venture investor of all times is Sequoia Capital.
2) Connections — VCs inherently like to invest in syndicats, especially at the early-stage, as that spreads out the risk. After all, a handful of firms working together actually makes it more likely your startup will succeed. Chances are as you talk to a VC they will suggest another VC you should talk to, potentially offering to intro. At that point you should be asking if there is any connection between the firms. Here are some potential connections:
- Fund of Funds — VCs that are invested in other VCs, especially a larger fund looking to harness the deal flow of a smaller fund.
- Sister funds — Funds that have the same or very similar base of LPs.
- Ex-colleagues / classmates — People who used to be colleagues in the same place now collaborating across firms, something that is almost the norm in VC
- Regular coinvestors — firms that often coinvest together just simply based on history
As an entrepreneur you are very unlikely to know the nature of a relationship upfront. Some may be self-evident if you look at portfolios and partner backgrounds. Regardless, you have the full right to ask for disclosures and should be doing it as part of your diligence during a fundraising process.
3) Legal Framework — Two aspects are especially relevant here: the fund’s structure and their trademark.
- Structure — Most VC funds are 10-year funds, making new investments only in the first five years, and follow-ons throughout this time period. The amount for follow-on varies hugely, small funds typically keep less, large funds more, the median seems to be 50%. Finally, funds are traditionally 2 and 20 i.e., 2% of is used to run the fund and 20% of the profits (“carry”) goes to the fund managers, the rest to the investors (“limited partners” aka LPs). How does this matter to you as an entrepreneur? It’s extra credit because understanding how your investor is structured can enlighten how they will invest in you. A fund that has a shorter life cycle is looking for a quicker exit. A fund with less follow-on in reserves will probably not be able to invest in future rounds. A fund with a lower fee structure is optimizing to put more capital to work.
- Trademark — The unavoidable reality in VC is there are many companies with very similar names. Different funds with the same name across geographies, or the same fund with different names across geographies also happen. If you have just engaged with someone and want to be 100% sure, do look up the fund’s website and ideally the partner’s LinkedIn.
Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.