Keys:

1. 95% of VC funds fail. In addition to your passion and commitment, bring operational experience to juggle investing, fundraising, and running your small business.
2. In the VC model, labor is a scarce resource. If you build a larger Fund II or III, consider the toll a higher volume of deals will take on your labor force.
3. Most VC funds are under-diversified. You’re going to learn as you invest and the world will evolve as well — give yourself enough flexibility to readjust, adapt, and take advantage of the opportunities that come your way.
4. When you’re in Fund I, you’re already raising for Fund II. Maintain close communications with current LPs and use their support to close prospective investors. If any investors step away, make sure you’re prepared to answer the question of why.
5. In the end, get ready for a lot of hard work before you see substantial payouts. Make sure you’re getting joy out of your work or don’t commit to this 10+ year path.

Your VC fund is a startup, just like the ones you’re investing in. It’s a competitive, volatile environment with huge pressure to perform and high failure rates. How do you make it past Fund I to Fund II, III and beyond?

We spoke with Dave Lambert of Right Side Capital Management, a pre-seed tech startup firm that recently launched their Fund IV. Based in San Francisco, RSCM has built a diversified portfolio of startups across the US. Before RSCM, Dave was the CEO & founder of both Acorn Computer and WorkMetro.

Welcome to part 4 of 4 in our series for first-time and emerging managers! Take a look back to learn more on how to raise your first fund:

Part 1: Understanding the ecosystem, leveraging your network, & building your team
Part 2: Building your fund and developing your thesis and pitch deck
Part 3: Pursuing LPs as leads and getting the yes

How many VC funds fail?

That depends on your definitions of “success” and “failure”. Many funds break even or see modest returns on their investments, but that’s not good enough for investors or long-term fund performance. Data from Correlation Ventures suggests that 65% of VCs fail, returning less than 1x what they invested.

Others place the “venture rate of return” threshold at 3x returns and conclude that 95% of VCs fail to return enough to justify the risk, fees and promises to their LPs. This owes to the fact that VC funds operate on a power law curve. Only a small amount of investments and firms capture the majority of returns. The rest make middling returns or lose money.

How do you make it to Fund II, III, and beyond?

It’s challenging enough to identify and make investments that will create extraordinary returns. On top of that, GPs have to juggle fundraising, manage current investors, and handle the fund as a business itself — including employees, payroll, and HR and capital management and operating costs.

Oftentimes, Dave added, you’re also starting with less funds and staff than expected. It takes a long time to raise your first fund and there’s only so much to show for it. This means GPs are operating a small company with less bandwidth on a lower salary.

How do you keep all the plates spinning?

No matter what, it won’t be easy to keep up with diligence, deal flow, LP management, fundraising, legalese, and all the challenges of a growing company. It goes back to your background, track record, and team. According to Dave, managers with operational experience can manage all the plates better. They’re already accustomed to, or at least have experience with, handling these matters.

Secondly, what team have you built to face these challenges? For instance, although legal and accounting work will get outsourced, you still need a knowledgeable partner within the fund. Make sure to surround yourself with partners with complementary skill sets and a passion for the fund that matches yours.

Where do you go with Fund II?

Do you build Fund II as a larger fund, as a follow on fund, or as a continuation of your Fund I strategy? This is one of the biggest challenges.

Oftentimes, successful early-stage firms choose option A: build a larger fund. However, “instead of doing what made them successful,” Dave conveyed, “the default is to write bigger checks.”

Raising a larger fund and writing bigger checks moves the fund into a completely different investment stage with a different return profile and ecosystem. “Many funds go from successful to struggling, and it’s hard to avoid,” Dave added.

Instead, cut the same size checks. However, with the larger fund, you’ll need to bring in more deal flow, perform more due diligence, and make more deals. Fund managers need to then bring on more people to keep up with the workload, but hesitate as it spreads the management fees even thinner. Funds that neglect to recognize that they need a larger labor force to get this done will fail.

“In the VC model, labor is the scarce resource”

It’s difficult to keep pitching your vision when you don’t have much evidence accrued from Fund I yet, but if you really believe in your thesis, stick with it. “There’s a lot more randomness and luck involved in success,” Dave admitted. Stick with what has brought you success and convinced your first LPs to sign on, and make sure you manage your bandwidth. Is now the right time to scale up for you and your fund?

Pivot or persevere?

What do you do if you’re missing out on opportunities? Is it wise to change and adapt if your thesis is too narrow, or should you persist with what you’ve planned?

Most VC funds are under-diversified. If you don’t think your thesis is working, definitely change, but be reasonable with the changes. First-time fund managers tend to give themselves too small of a box to operate within. Dave advised, “You’re going to learn as you invest. The world is going to change as well, so you need some flexibility to adjust with it and make the best decisions for your fund and investors.”

The key is to communicate any changes clearly with LPs before they happen. Take advantage of your resources — reach out to your LP committee, explain why, and get their advice and thoughts.

When do you start fundraising for Fund II?

You never stop raising. When you’re in Fund I, you’re already raising for Fund II.

This is one of the challenges of managing a fund. “You should always be out there talking to potential LPs, making them aware of the fund’s work with quarterly updates,” Dave said. This will help them make a quicker decision when it comes to committing. It’s also a good time to circle back to anyone who was close to investing or wanted to invest in Fund I.

Bring your metrics and returns from Fund I, but understand that there still may not be a lot to go off of. Dave found that investors are much less data-driven than they think they are.

A lot of LPs believe data more easily when it aligns with a thesis they already believe in. There are a lot of ways to describe what you do and what your goals are. Craft the story that resonates well with your target investor profile, and keep bringing your passion and conviction.

What do you do if investors have decided to not invest further?

It’s a very strong signal for future funds if your original investors return. But if some of them don’t, it may be an issue. It depends on the profile of the investors, Dave shared.

It can be a red flag if an institutional investor doesn’t stay on. They may have concerns about ROI, a member of the team, or the fund as a whole — take their concerns to heart and reevaluate if changes are needed.

If it’s an individual or smaller family office — their financial situation has changed or they can’t afford to keep investing until there are greater returns — it’s not ideal if they can’t continue, but it doesn’t market badly.

Do your best to retain existing LPs and use them to create FOMO and get new investors to commit. If there are investors stepping away, make sure you’re prepared to answer the question of why.

In the end

Get ready for a lot of hard work. The vast majority of VC funds fail. When you decide to start a fund, you’re putting yourself on a 10 year path of hard work before you see substantial payouts.

As Dave said, “Adjust your expectations down a lot. It’s a lot less glamorous than people think.” That’s why it’s so crucial to anchor your commitment. You need to have the intrinsic desire to boost the startup community, help entrepreneurs, and work closely with investors.

“If you’re not getting joy out of it, don’t commit to this 10+ year path”

During this chaotic time of managing your investments and business, remember to manage yourself as well. Surround yourself with advisors, colleagues, friends, and family you can lean on. Find mentors that are 1–2 years ahead of you and can guide you along the journey. Carve out time to step away from work and take a breath when you can — take care of yourself so you can bring your best to what you’re passionate about.