Four Ways To Analyze A VC Fund

Venture capitalists are, in fact, entrepreneurs. Every ten years, General Partners (GP) raise money from one or more Limited Partners (LP) to make up their fund. 

There are different size early stage funds; small funds are under $50 million and anything higher than $1 billion is huge. In 2011, the average fund size was $150 million. Overall, the VC industry is less than $300 billion – a fraction if you compare it to the private equity industry, for example. 

If you’re an entrepreneur evaluating which VC firm to raise your Series A funding from, you should do some research on the VC firm and take a close look at their fund size.

There are four major determinants of fund size:

• Number of partners
• Stage
• Diversification
• Prior returns

Number of Partners

The biggest constraint is time for General Partners. VCs source new deals, do intensive due diligence, meet with their partners, manage the firm and work with their portfolio companies. Typically the VC who leads your Series A round will take a board seat at your company. How many companies do they have in their portfolio? Which partner do you want on your board? How many boards do they sit on? How much time will your company get with the VC?  

Stage

Early stage deals are much smaller, so VC funds are smaller. In 2004-2005, the median-sized Series A round was $1 million. Now we’re seeing $2.5 million Series A rounds because of angel investors and incubators/accelerators. Does the VC specialize in a specific stage of a company’s development? What is the deal size of their recent investments? 

Diversification

Given the high risk of each new investment, VCs are looking to invest in a number of companies across several years in a typical 10-year fund lifecycle. What other companies are in their portfolio? How old is the fund – is the VC in the early (1-2 years), mid (3-4 years) or late stage (5-6 years) of the fund? What’s your company timeline? Where will your company be in year 10? On average, it takes 6-8 years for companies to IPO and exit times are now taking even longer. 

Prior Returns

VCs start their future fund-raising efforts during the late stage of their existing fund. It’s critical for VCs to show profit from their current fund to raise a new fund. Both past performance and reputation help VCs raise larger funds, which is why you see a well-known VC firm like Kleiner Perkins closing bigger early stage funds. There’s empirical evidence that success begets success:

• More successful funds are more likely to raise more funds
• More successful funds are likely to raise larger funds
• More successful funds are likely to charge higher carry interest

Funds with poor performance will significantly lower a firm’s ability to raise new funds from LPs. Many VC firms are forced to shut down. In 2000, there were 70% of venture-backed IPOs in the United States. In 2008, venture-backed IPOs dropped to 30%. 

Source: Stanford Graduate School of Business