VC Primer: Source of Funds

Tom Evslin:

You already know that venture capitalists were invented to supply entrepreneurs with the money we need to make dreams happen. You probably also know that they won’t provide any of that money unless they think your dream has the potential to become a hard reality which returns TO THEM many times their initial investment and unless they believe you are a dreamer who can execute.

But it’s also important to know where they get that money which you need to have them pass on to you and how they actually get compensated. You should always understand the needs, motivations, and constraints of the people that you negotiate with. Moreover, the VCs who supply you with money will become a part of your very full start-up life.

Some venture capitalists (rich ex-entrepreneurs, for example) simply manage their own money or family money. Other venture capitalists are hired by a single very rich individual to manage a venture fund for the individual. A third type of venture fund manages the venture investments for a company like Intel or Cisco or Microsoft. What these three types of fund have in common is that they DON’T have to spend time raising the money they are gonna pass on to you. They already have it. In theory, this leaves them free to spend all their time on their investments.

The most common type of venture fund DOES have to raise money — in some senses it is an entrepreneurial enterprise itself. A VC firm (not the same thing as a fund) is the GENERAL partner of the fund. The bulk of the money in the fund, however, comes from the LIMITED partners — they are the actual investors. When a new VC firm sets up shop, it has to spend a huge amount of its time recruiting these limited partners and selling partnership units to them.

Although a VC firm may talk to you about your dream before they have actually closed their own funding, it is unlikely they will be able to give you the money until they get it themselves (sometimes the general partners have contributed enough capital for some starting investments). You certainly want to know whether the firm you are talking to is actually in a position to invest or whether the money you need is contingent on their closing their funding.

via Daredevil Planning Guide.

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