Ever wondered what the process is behind raising a venture capital (VC) fund?
For the latest episode of Disrupt Podcast’s “The month in VC” series, produced in partnership with Katapult Africa, Kalon Venture Partners, and Hlayisani Capital, we discussed the mechanics of raising a fund, and how GPs and LPs work together once that has been done.
All three of those companies are actively raising funds as we speak, so had valuable insights to share. One key takeaway – a VC raising money isn’t that different to how a startup goes about securing capital.
“We often explain to companies that come to us to raise that we really do understand what it feels like. We’ll be having a meeting with an entrepreneur, talking about their possibilities and either going further down the road or rejecting them, and then in the next meeting we’re going and pitching ourselves and our fund in the same way,” said Brett Commaille of Hlayisani Capital.
There is one key difference between a startup that has raised capital and a VC fund, according to Philip Gasaatura of Katapult Africa.
“A startup can pivot, whereas for a fund not many LPs want you to pivot. They like you to stick with the thesis,” he said.
VC funds also take a bit longer to raise than a startup round, often taking a couple of years. It starts with targeting particular prospective LPs.
“The way we go about it is mostly identifying everybody that we are aware of who has a stated mandate to do so. So we don’t chase after those that have explicitly excluded VC from their mandates. We look at our networks, go to all the family offices that we believe may be interested. It comes down to hitting the streets, getting on a plane, meeting people, pitching, pitching, pitching, and following up consistently. It is an exhausting process, but one which is essential in our space,” Commaille said.
“There are certainly those that have been fortunate and turned up one day with someone saying “I happen to have a lot of money, do you want to invest it?”. I have heard stories like that, but for the rest of us it is a matter of years of building a track record and then finding investors you believe have an aligned vision with what you want to do.”
Gasaatura says key to fundraising is identifying the best “customers” for your “product”
“A fund is a product, and you are looking to provide a service for someone that has come to the market. So we are targeting those whose strategy fits with what our product, or investment thesis, is,” he said.
It is important to be selective about who invests in your fund, however, for a variety of reasons.
“I’ve watched transactions happen where people have taken money from someone that has a very different alignment, a different timeline to what they expect, or a different set of ethical values. And those things have always bombed out horribly. So it is just not worth it. It is like saying “I’m lonely, and therefore I’m going to marry the first person I meet”. Which would be an insane sentence to utter. Yet I think people often do that, they brush aside their concerns when it comes to taking funding,” said Commaille.
“Whereas for us there are many places where we won’t take funding from. And it is not necessarily a moral or ethical issue, it can just be a misalignment of expectations. So somebody who is investing into a VC fund, you need to know that your money could be tied up for 10 years. If you’re expecting a return in the first year or two, a VC fund is not the place to go. And if you invest your money and then a year later start demanding it out, that’s going to cause a massive amount of tension, and that is the kind of thing that breaks relationships.”
Clive Butkow, from Kalon Venture Partners, agrees there are scenarios where VC firms should decline to work with certain LPs.
“A VC company needs to be selective about where they are raising money from, similar to a startup raising money from a VC. There needs to be a cultural fit and trust between the two parties. No VC firm should take money from an LP if they are going to get micromanaged or any such dysfunctional behaviour,” he said.
Often, potential LPs without exposure to Africa will need some convincing.
“If someone asked me to invest in Guatemala I’d find it very tough because I don’t know that market. So those that don’t have exposure will take a bit of warming up to the idea. I think for those that don’t, the key question is whether they are looking for a certain exposure. Maybe they’ve done climate in Europe and Latin America, and they are looking at still doing climate but in a different geography. So you are really looking around the thesis,” said Gasaatura.
Once funds have been raised, how do GPs and LPs interact? Commaille said the type of reporting that gets put in place often depends on how institutionalised the LP is.
“On the one extreme you may have a family office who may be less formal, who just wants to know whether the companies are doing well, and if they are not doing well, they need to shake their boots,” he said.
“On the other hand, you have institutional investors who want to ensure that they get quarterly reporting on the performance of each portfolio company, checking how we are valuing the companies. So there is a formal process that happens. All of our investors get the same level of reporting, and it is reasonably detailed. Ultimately we are trying to ensure two things – firstly that they are informed, and that they are confident about how we are managing these assets. Because ultimately if they are confident they will want to follow-on and put money into the next fund as well. And the other part of that reporting is that if they see it is possible to add value to those companies then they can do so.”