Developing your fund strategy

Your fund strategy—which is how you decide to use your capital to generate returns—largely dictates your success. Without a clear investment thesis and effective portfolio construction strategy, your fund may not get very far. 

Why? Because breaking into the venture capital realm is challenging and competitive. LPs have invested more than $40 billion into venture funds every year since 2015, with investors putting $73.6 billion into venture funds in 2020. But despite the steady supply of institutional capital, annual allocations to venture remain concentrated into just 300 to 500 funds, according to the Venture Monitor Q4 2020, by the National Venture Capital Association and Pitchbook. Fewer than 100 new funds close in the U.S. each year; this has been consistent every year but one for the past 20 years – in 2018 when 129 first time funds closed, according to the same report. 

To compete with other venture capital funds, you need to be able to differentiate yourself, while creating a plan that’s realistic and sustainable. Your fund strategy should align with your capabilities, network, market opportunities, and LP interests. 

These three key steps to developing your fund strategy could be a good place to start: 

As venture capitalist Mark Suster has written, your fund size is your strategy. The size of your fund influences almost every element of your investment strategy: the number of companies in your portfolio, your check size, the amount of reserve capital you have, the LPs you attract, and the return profile for your fund. Your fund size also determines your management fees, which then dictate the operational expenses you can realistically support. 

To determine your ideal fund size, start by researching funds with goals and benchmarks like yours to see how they’re faring. You may also want to research successful funds across a handful of different industries and sectors to see what works.

Next, do a pricing model to map out your fund’s potential financial constraints and growth. What size investments do you plan to make? How many investments do you need to make over the course of a year to generate significant returns? What about over the life of the fund? Plugging in possible numbers and scenarios will give you a better idea of the fund size that makes the most sense for you.

Once you’ve settled on a fund size, the next step is to outline the stage, sectors, and types of founders you’ll invest in. Articulating your investment focus doesn’t just help you to narrow your aim and convince the right LPs to get on board, it also makes it easier for founders to self-qualify and approach you for guidance. 

When you’re defining your focus, consider the following: 

• Industry: Which sectors are you interested in? Do you plan to target a specific industry like healthcare, or focus on similar companies across a handful of different industries? 
• Stage: At what point in a company’s life cycle do you want to invest and offer guidance? If you’re interested in being a sounding board for founders who are just getting started, you might want to invest at the seed stage. However, if you prefer to work with companies that already have steady revenue and an established business model, you’ll probably want to jump in at a later stage.  
• Geography: Where are the companies you’ll be investing in? What particular challenges and assets do they have because of where they operate? You may choose to invest in local companies if you already have a network of contacts nearby. On the other hand, if you’re open to traveling or want to capitalize on lesser-known markets, you may want to expand your reach.  

Special considerations: Depending on your investment goals, you might have other criteria to look at, like a company’s social impact, environmental influence, or commitment to diversity, equity, and inclusion.

A thoughtful portfolio construction strategy is critical to running a successful fund. Your portfolio construction model gives your LPs insight into how you plan to allocate capital. 

It’s essentially the roadmap for the life of your fund, spelling out the number of companies you’ll invest in, the amount of capital you’ll pour into each company, your target ownership for each company, how much you’ll set aside for initial investments, and how much you’ll reserve for follow-on investments. Your portfolio construction should touch on the following on some of the following elements: 

• General portfolio strategy
• Diversification
• Check size
• Investment horizon
• Expected returns
• Investor requirements

One way to ensure that your plan is successful, you need to evolve your portfolio construction model as the markets change. As you gain more visibility into your portfolio, set aside time to regularly evaluate whether or not your investments align with your original model. If your investments deviate from your original thesis, you will need to adjust your model or reset your focus.