Three Exercises Every First Time Venture Fund Needs to Work Through

Some VCs peel off of other funds to start their own and they have the benefit of a track record from their previous firm to show. Obviously, that’s ideal, but that’s not where everyone starts.

If you’re lacking for track record as a firm, here’s three exercises you should walk through to help turn your pitch and due diligence meetings from guesswork into something more substantive.

The Fantasy Cash Flow Model

When I was an analyst at the General Motors pension fund, investing in VC funds, I had to build a model of how I thought they would perform. It started out with initial investment size, pricing, and outcome behavior for each deal and then it made a prediction around the distribution of outcomes.

It’s easy to say you’re going to be a 3x fund, but how does the math actually get you there. If you’re not actually modeling this out with a spreadsheet, I don’t know how you can look an LP in the face and say this. Build up your model of what you think the individual financial outcomes will be over time—layer that on with follow-on decisions, fees, carry, etc. I think the results will surprise you how hard it is to be successful.

A Time and Attention Model

How much time will you be spending on each portfolio company? Taking board seats? For how long? How long is your partner meeting going to be? Will you be going to the gym at all? Spending any time with family? How much do you sleep?

You give money away for a living—and so you’re going to get overloaded with requests. Once you do distribute the capital, you’re giving it to companies that will need a lot of help. How will you provide it across 30 investments? Will you have analysts? Partners? Will that increase the work?

Figuring out how you’ll spend your fully loaded time is something any LP will want to understand in order to know if you can handle going from just angel investing or doing whatever you were doing before to running a portfolio full time. Here’s what my model said.

The Backtesting Model

In the public markets world, when you start a new fund, you backtest it. You take your investment model and run it against the past to see if it would have worked. Want to only invest in diverse boards? Only companies with a certain contribution margin? Maybe you only care about growth. Whatever it is, could you have run that model successfully over the past five years? Not all prior performance is a guarantee—but it would be nice to know if this would have worked in the past.

I ask the same of new managers. Had you actually had your fund in the four years prior to today—which deals would you have legitimately been able to do? This is actually easily referenced.

For example, let’s say I had a more national fund. Because I had previously met Jack Dorsey through the Union Square Ventures network, in 2009 I was able to grab coffee with him before he launched Square. He demoed the product to me and I wound up being dollars #476 and #477 to be swiped on the very first Square prototype. I was blown away.

Had I had a fund, I could have said, “Hey, let me invest in this…” and maybe I could have squeezed $25k into the round. It’s at least plausible—versus being someone who had never met him at all who said they’re starting a fintech fund and Square is the kind of thing they would have invested in. It wasn’t likely that a fund who had no prior connection to him at all would have gotten in.

If you’re looking for more tips and advice on starting out as a first time fund manager, you should check out the webinar I’m putting on with Carta next week covering all the basics and stupid questions that aren’t so stupid.

You can RSVP here: https://www.eventbrite.com/e/best-practices-for-new-and-emerging-vc-funds-presented-by-carta-tickets-58679227148