In the 1990s and early 2000s, there was probably only a tenth of the number of funds that there are today. At that time, a very small subset of VC firms had a very high concentration of influence in the industry. In the past 20 years, though, the VC world has democratized significantly: there are more new fund managers than ever, diversity has become a key focus area, and information about raising capital is no longer the privilege of a select few.
The Democratization of VC
Around 20 years ago, two significant shifts began to shake up the VC landscape. One was a proliferation of new funds, either through spinouts of existing funds or from operators starting their own funds. In terms of supply and demand, there began to be a larger supply of people who were interested in becoming VCs.
Another shift happened on the “demand” side. Venture has always been very much a niche market within alternatives: venture is a relatively small location relative to private equity or hedge funds. What we’ve seen, especially in the last five years or so, has been a move from venture being a niche part of alternatives to a much more mainstream part. Ventures began to attract a lot more attention, not just from large institutional investors but also from smaller family offices. People who might once have considered ventures too risky began to be interested in driving more risk.
I think this change in attitudes has been facilitated by several factors in today’s environment. One has been the proliferation of technology tools that make fund management much easier. For example, at AngelList, there are a lot of funds that run the back office, as it were. This is important because of the costs involved with running a back office. AngelList acts like the AWS of the back office of fund management for rolling funds and seed funds, for example, and this reduces the amount of friction involved in starting a fund. In essence, what this has done is made raising, say, a $10M fund economically viable–previously, smaller funds would be hamstrung by the costs of things like back office operations and reporting. It would be hard to pay for service providers with the management fees from a $10M fund, even if the providers were only working part-time to manage your fund.
Another factor in today’s environment, especially after 2020, is that tech has become truly mainstream. What does this mean? Prior to 2020, tech was seen as a sector within the economy–a fast-growing sector, perhaps, but a sector nonetheless. I think that what happened with COVID is that tech became completely mainstream. Every industry is tech now, and if you don’t touch tech you’re simply no longer relevant. We saw this reflected in the share prices of companies: those that were able to succeed and grow rapidly during the pandemic were rewarded handsomely in the public markets. Those that were not fell significantly behind. This drove the appeal of technology investing, which proliferates even down to the interests on the LP side.
Founder-CEOs in the VC World
All of these changes have led to the democratization of VC. 20 years ago, you raised a fund, had a few partners, and committed to the fund for 10 years. You needed to raise a certain amount of money in order to justify the back office operations and hire the right people. In short, you were building something for the long term. Today, a number of people who have their own venture funds are also doing other things. For example, there’s been a trend of founder-CEOs who have small seed funds on the side. The rationale is that prominent founder-CEOs get a lot of interest in deal flow. There are a few ways in which these types of investors get traction. First, they’re successful and are using their own capital. Second, they might have close relationships with VCs on their board. These VCs often provide capital to invest in scout programs at a number of venture funds now have. Founder-CEOs don’t need to spend their own capital on these initiatives but they do receive economic interest or performance based incentives, similar to carried interest.
From these beginnings, founder-CEOs have expanded to initiatives like AngelList rolling funds, where they can connect with a variety of outside LPs. These might be retail LPs or family offices, for example, who are investing in an AngelList syndicate or rolling fund. Founder-CEOs also raise standalone funds with institutional LPs. Ironically, a lot of investors in these funds tend to be general partners of other VC firms who are looking for access to information and deal flow. A number of GPs at established venture funds have invested in many seed funds themselves – either personally or through their funds, primarily because they want earlier access to these funds’ deal flow.
This kind of democratization would never have happened, say, 20 years ago: at that time, if you were starting your own fund it was a full-time effort and you were going to focus on institutional LPs. If you were spinning out of an existing VC firm, the best you could hope for would be for that firm’s partners to introduce you to their LPs and maybe invest themselves as a vote of confidence in your spinoff fund. Nowadays, though, you don’t need to come from a Sequoia or Kleiner Perkins to start your own fund: there are so many different people starting their own initiatives like syndicates or SPVs. And importantly, they might not even be doing it full time.
The State of Early-Stage Fundraising Today
The longer a fund has been around, the easier and harder it is to raise capital. At DCM, we’re currently on our 14th fund and 9th flagship fund. At this point, we have a lengthy track record and a set of LPs who have been with us almost from the very beginning. But an established fund like DCM needs to continue delivering superior returns in order to persuade LPs to stay with the fund. To the extent that you’re delivering on your investments, it’s actually relatively straightforward to raise capital: you’ve built a franchise, you have LPs who have made money through you, and they want to continue to support you. From this perspective, it’s certainly easier for an established fund to raise money. However, if you stop delivering the same returns your LPs can hold you accountable and it can become much more difficult to raise capital.
At the earliest stages, the fundraising process is much more story-driven. The evolution of an early-stage VC fund is very much like the evolution of a startup raising capital. For startups, at the seed or series A stage, you’re showing signals of product-market fit. At the same time, though, you don’t really have much data to back up your claims. Likewise, on the fund side, when you’re raising fund 1 or 2, a big part of the process is convincing potential LPs to believe in and commit to your long-term story.
The ROI bar can often be higher for early-stage VC firms since they need to deliver a higher multiple of the fund simply because the fund is smaller. But once you deliver that higher multiple, you get “permission” from LPs to raise larger funds and seek out different types of investors.
Two Common Mistakes New VCs Make
Along these lines, one mistake an early-stage VC can make is to raise too large of a fund too soon. This is akin to raising a large series A round before you’re really ready. I think that the number one thing LPs look for is for early venture funds to show strong signals that they’re going to consistently deliver returns. Raising too much money too quickly might skew expectations and put undue pressure on a fund to keep delivering.
A second mistake is the type of LPs an early-stage VC might pursue. Many LPs only want to invest in established funds (say funds 3 or 4); they won’t invest in first-time fund managers unless they already have a relationship with them or they’re spinning off a well-known fund. But if you aren’t part of that ecosystem, these kinds of LPs probably won’t be interested until fund 3 or 4. Likewise, early-stage VCs shouldn’t pursue investors like pension funds: these kinds of large investors typically write $100M+ checks, so if your early fund is much smaller than that they’re unlikely to invest with you even if they’re interested.
Advice for Emerging Fund Managers
One key piece of advice for pursuing LPs is to remember that relationships take time to build. It’s a good idea to begin talking to LPs you would want in your next fund while you’re still raising your current fund. This way, you get on their radar, and if your fund does what you say it will then the relationship you already have will increase the likelihood that they’ll invest with you next time.
It’s also important for early-stage funds (and any sub-$100M fund, for that matter) to focus on securing one or two anchor LPs who are willing to back the fund and give you the momentum you need. The fundraising process is much more difficult for early funds without an anchor, since LPs are always on the lookout for positive signals about a newer fund. It’s very much like finding a lead investor for your startup round: it’s much harder to raise, say, a $20M series A if you don’t have a lead. You might find a bunch of people who are willing to commit small amounts of funding, but you really do want a lead investor who will sit on the board and put in the hard work. The situation is almost analogous for early-stage VC fundraising.
Diversity and Underrepresented Voices in VC
The focus on diversity in the venture ecosystem is something that’s very different from 20 years ago. To put it plainly, back then there wasn’t much emphasis on diversity. To take an example, David Chao, one of the founders of DCM, was one of the first Asian-American VCs in Silicon Valley, and this was only 24 years ago! Nowadays many groups are distinct minorities in the industry but aren’t as underrepresented as they once were. Still other groups are significantly underrepresented and I think the industry is finally waking up to that.
Today there are specific initiatives aimed at getting underrepresented VCs involved. Retired partners–including some at DCM, for example–are passionate about funding a new generation of diverse emerging managers. Some retired partners I know run an incubator for emerging fund managers, and although they don’t have an explicit focus on underrepresented VCs the cohort is very diverse. So diversity is clearly an important consideration for them even if it’s not the incubator’s main focus. I think you’re seeing much more diversity today in programs like these for emerging managers.
The Future of VC Fundraising
Up to now, venture has been relatively undisturbed by technology but I think the industry is ripe for disruption. Let’s take the example of IPO roadshows: these used to be rolling events where you’d fly to the major investor hubs and gather interest for your IPO over the course of four or five days. These were always done in person because investors wanted the comfort of being able to sit across the table from executive teams.
During COVID, investors realized that they didn’t really need that kind of in-person contact. I think things have become much more efficient, especially since virtual meetings make it easier to get in front of diverse groups of investors. I think this is one pandemic-related change that’s going to persist going forward. A change like this also enhances the democratization of the fundraising process. It’s going to be easier to find different types of limited partners and venture investors, and this diversity will raise the quality standards for everybody.
The democratization of information will also continue to grow in the future. 20 years ago, only a small subset of experienced entrepreneurs knew how to raise capital. Now, there are networks, incubators, and accelerators where emerging VCs can learn the ropes. Thanks to AngelList and other information sources, there’s almost no such thing as proprietary deals anymore. The market has become much more efficient thanks to the wider distribution of information, and I think this will only intensify in the future.
To continue to explore these topics, read DocSend’s first-ever research on trends in VC fundraising.