How do VCs get their money? They pitch too

Every two or three years, VC’s gear up to raise money for their next fund. They create a pitch deck, come up with a list of investors actively investing in venture capital funds, make sure they get introductions to them from trusted sources — or go direct if they already have the relationship, and pitch the investment strategy and how they plan to provide better returns than the industry average. Sound familiar?

For established funds with a solid track record (an established team with a specific investment style and realised returns on previous investments) it can be as easy as going to their existing investors to get new “commitments”. If you are raising a first time fund then you have to take an entirely different approach.

But first, a quick explanation of the three players involved in the fundraising process.

First, there are General Partners or GP’s. The GP’s are the VC’s. They manage and invest the fund on behalf of their investors or the Limited Partners — LP’s. More often than not, the VC’s have to invest personally into the fund. This is called having “skin in the game”. Remember, the life of a fund is 10 years. So this is a long period of time to have your money locked up and be illiquid. LP’s are typically professional institutions such as University Endowments like Yale and Harvard, global insurance companies and investment banks.

The third set of players involved are the companies that get invested into by the fund. You could argue that this is the most important part of the equation. If there was little demand for venture capital from startup and growth companies, then it would be hard to justify to LP’s that there was a real market opportunity.

The actual fundraising process isn’t too dissimilar from founders looking to raise money from a VC. We pull together a pitch deck which has hard data on our previous fund performance. This ranges from the past investments we’ve made and their success (and many times failure!), to information on the individuals in the fund including their backgrounds and investment track records, to the fund investment strategy, to our personal outlook on the market that we are looking to invest into. This process can range from a few months to a couple of years in some cases. I spoke with a placement agent recently (a placement agent is a third-party service provider who helps funds raise money for a fee) who said the average length of time to raise a new fund currently is just over a year.

The fund that we are currently investing out of had a final close at the end of 2010 and we raised US$150-million. Two of our Managing Partners led the bulk of our fundraising and travelled to over 10 countries across three continents to raise our money. This is a long and gruelling process as they also have to manage their existing investments and are still investing from the existing fund.

I have oversimplified the fundraising process, but this should give you a basic understanding of how and where VC’s go to raise their own money.