The first time I tried to raise venture capital was a flat-out failure. I was an operator turned founder, and my startup, although early, had real velocity. But my attempts at raising went nowhere, and at the time I didn’t understand why.
Back then, I had a sense that angels were different than VCs, and that some VCs invested more than others. But mostly I was just focused on my company, and under immense pressure to get funding. Any funding. So I plowed ahead, treated all investors alike, my pitch a blunt instrument to be tested on anyone who would pay attention.
In the five years since then, I went from failing to raise venture capital to running my own venture capital fund. In the process, I’ve met and evaluated thousands of companies, first as a community leader, then as a mentor, then as an angel investor, and finally as the managing director of Graham & Walker. To say a lot has changed is an understatement. I still have the instincts of an operator and founder, but I now evaluate companies through the lens of a VC. It makes a huge difference.
To quote the great Alanis Morissette, “Isn’t it ironic?” So much of what I learned would have helped me succeed back then. But I wouldn’t have learned it if I hadn’t tried and failed.
Experience has taught me that not all investors are alike. Angels invest their own money, some with discipline, others freely, others sporadically. Most VC funds have strict processes and parameters in place that dictate how much they invest, how often, and in what types of companies. But most founders I meet don’t know the difference, just like I didn’t back then. And if you don’t know who you’re pitching, the odds—which are already against you—get way harder.
Channeling my journey from angel to VC, and with the input of some of the most prominent emerging venture capitalists today, these are the biggest differences between how VC funds invest compared to individual angel investors.
Every investment VCs make must have the potential to “return the fund”
Outcomes that are great for angel investors may not be substantial enough for a VC, even if they seem like a sure thing. A simple example to illustrate what this means: Imagine an angel investor that comes across a company and decides to invest $50,000. Two years later, that company gets acquired by a larger competitor, earning the investor $250,000 – a 5x return. This is a great outcome for the angel.
Now imagine that same investment from the perspective of a VC fund. Let’s say this VC fund has $1,000,000 to make 20 investments for $50,000 each. Most of those companies will go on to fail, which means the VC will not get any money back. Let’s say 19 of the companies fail, and the 20th company—the same one from the example above—gets acquired by a competitor. The VC gets $250,000, which is not even enough money to pay its own investors back for the full $1,000,000 that they invested. This is a very bad outcome for the VC.
Shila Nieves Burney, founder and managing partner at Zane Venture Fund, explains:
“I have a fiduciary duty to find the best deals that will have a return on investment for my LPs and my team. When I was an angel investor, potential returns were not important, I just wanted to see diverse entrepreneurs succeed while building their dream company. Today, I want to do both, with a keen eye to companies that are building the connective tissue economy where we all thrive.”
This is why VCs look exclusively for VC-sized opportunities, those that have enormous potential future revenue and enterprise value, and can therefore independently return the entire fund. There are many great, solid businesses that are not VC-sized opportunities, and there is no value judgment attached to that statement. It’s the context that matters: VCs are not in the business of investing in great companies of any size, we are in the business of investing in great companies that are also potentially massive.
VCs do much more diligence
When pitching to VCs, founders should expect a much deeper and longer due diligence process compared to when they pitch angel investors.
“I take the level of responsibility of investing other people’s money incredibly seriously. One of the most obvious places this shows up is in the due diligence process,” says Kate Brodock, general partner at the W Fund. “The diligence isn’t necessarily less thorough when investing as an angel, but it can certainly be less formal, with more room for the ‘gut’ to show her face. When investing through the fund, our diligence is more formal and frameworked, and purposefully involves a several-step decision-making process.”
“The level of diligence and support we provide to companies is vastly different as we invest our LPs money,” says Diana Murakhovskaya, general partner and cofounder at the Artemis Fund. “It goes a lot deeper than the general market and founder fit that I may look at as an angel. At Artemis, we do extensive founder references, deep dives into market research, technical diligence, and more.”
So if you ever hear anecdotes of investors that write a check on the spot, it is most likely that the investor in question is investing their own money.
If you’ve only raised capital from angels, you might be surprised when your first VC asks you for “major investor rights” in the form of a “side letter.” I can tell you as a founder that those are scary terms, especially when you don’t know to expect them.
Let me break it down for you.
Major investor rights generally fall into three categories:
- Information rights, or the right for the investor to be informed about your business results and key issues
- Participation rights, or the right for the investor to invest in your next round of financing (sometimes called pro-rata rights)
- Board membership, or the right for the investor to have a seat on the company’s board when formed
If the VC is leading a round, they will usually require a voting board seat. If a VC is not leading a round, they will sometimes require a non-voting observer seat. The Artemis Fund’s Murakhovskaya reports taking board or board observer seat on 90% of their investments.
VC funds are investing other people’s money, and we have a fiduciary responsibility to invest it responsibly, report to our LPs, and to do everything in our power to make the fund as successful as possible. That means we want to know how the startup is doing, so we can report on it transparently and provide help when appropriate. And it means we want to be able to keep investing—a right that sometimes needs to be protected from more aggressive investors that come down the line.
VCs have to invest with discipline
“As an angel, I could invest when I wanted and how much I wanted,” says Jenny Fielding, managing partner at The Fund. “Pacing was not a consideration.” That’s because angel investors have complete freedom to select what companies they will invest in, when, how often, and how much. It is their own money, after all.
VC funds are the opposite. We have strict parameters within which every investment opportunity is considered. These parameters are defined by the fund’s size and investing period, their target company stage, and their usual investment size. Following the example above, the $1 million fund that intends to make 20 investments of $50,000 each. If the investing period is four years, that means the fund will aim to make five investments per year.
Usually, these parameters are decided on before the fund is even raised, and are part of the legal and strategic commitment that VCs make to their own investors. The good news for founders is that this information should be easily discoverable. They may be listed on the VC’s website and in public databases such as Pitchbook or Crunchbase. Or you can make a good guess based on what you read about the fund’s investments in the press. If all else fails, ask other founders, or ask the VC themselves.
“Investing LP money requires clear communications, managing expectations, and lots of discipline,” says Pocket Sun, cofounder and managing partner at SoGal Ventures. “Our focus is on creating outsized returns for LPs within the fund term, and we need to stay true to the framework we promised our investors. We also act with great consciousness on how much we’ve allocated to what, and make every investment decision with a holistic view in mind.”
VCs are running companies, too
Founders might be surprised to hear that a VC fund is also a company, and as a fund manager, you have to run the company too. Recruiting, payroll, taxes, communications, keeping your website up. Large VC funds hire people to do all these things. Small VC funds can’t afford to. We do all the work with a fraction of the team.
“Running a micro-fund is not the same as being an investor,” says Fielding. “I spend one-third of my time managing the fund, one-third raising capital, and one-third investing into companies. I actually like the diversity as it reminds me of my founder days but it’s very operational so that was a surprise!”
For this reason, it helps when founders understand what type of fund they are talking to. If it’s a large fund, look for job titles that are clearly in the investing team—titles like managing director, partner, or principal. If it’s a small fund, assume that the investor is spread very thin—but they have much more appreciation for what it’s like to run a company.
Raising venture capital is hard. For first-time founders, a lack of knowledge and experience about how the system works acts as a true hurdle. First-time founders who are also outsiders, disconnected from the startup and VC ecosystem, have it hardest. And when you add to that a non-traditional founder profile—someone whose identity doesn’t match Silicon Valley’s highly homogenous pattern of success—venture capital goes from being hard to practically a moonshot.
The good news is that many emerging investors like myself and every VC quoted here have a stated commitment to opening doors to a new generation of founders. I hope this helps you understand our perspective a little bit better, so perhaps your first run at fundraising will have a more successful outcome than mine.
Leslie Feinzaig is the managing director of Graham & Walker.