I've heard from several readers requesting more pieces that teach about the basic ins and outs of venture capital. For those of you who don't read Brad Feld's blog, he has an awesome series that he calls "Term Sheet" in which he dissects the various sections of a term sheet from an investor's, entrepreneur's, and even lawyer's point of view. I highly recommend it. In similar fashion, I am beginning a series that I will call "VC Primer". I will begin this series with a discussion about Fundraising & Blue Sky Laws.
I guess everybody who has an interest in venture capital would like to know how to raise a fund. So, let's say you have an interest in raising a fund, where do you start? Well, let me first say that raising money for any type of endeavor is a difficult and overwhelming experience. If you've never had the experience of being a cold-caller or walking door to door for a particular cause, there are more similarities than differences. Most VCs got their start with institutional money. They probably worked at a VC firm for a while and had several successful investments. They then decided to break off on their own to start their own fund and hit up their previous firms LPs for capital commitments. The early founders of venture capital usually had a major benefactor. For example, the Rockefeller Family, had their own investment group that became what is today known as Venrock Associates. For those VCs that never had one major benefactor, they usually started small with personal money and money from friends and family. If they are still around as a VC today, it means they had good luck with their first fund, which enabled them to start a second. If you look at most firms that are not more than ten years old, you may find that they started with little money and little experience but benefited from the internet and the tech boom which catapulted their funds so that they are now here to stay. And lastly, believe it or not, some venture capitalists are actually born into it. Take Tim Draper of DFJ for example, he is a third generation venture capitalist.
Raising a fund is a complex task that involves laws restricting the manner in which funds are raised. These are called "Blue Sky Laws". No one really knows exactly where that name came from, but here is an interesting blurb that cites a case referring to these laws that are to prevent against "speculative schemes which have no more basis than so many feet of "blue sky"". Anyways, Blue Sky Laws are state regulations that basically prevent the solicitation of investors. These laws are meant to protect investors from getting persuaded into investing in risky investments that are not suitable to them. In fact, the general result of Blue Sky Laws is that investors usually are never approached for investment blindly. The investors themselves must initiate a request of information from the investment manager, who will then respond either with a questionairre or with information about the investment. The questionairre I am referring to is what is used to determine if the investor is "Accredited" according to the definition of the SEC's Regulation D. The reason that it is so important to follow Regulation D is that the SEC requires all offerings of securities to be registered with them. However, they have provided a few limited exemptions, and those include exemptions allowed under Regulation D. Offerings that do not adhere to an exemption must go through the costly process of filing the offering with the SEC.
Given Blue Sky Laws and the inherently difficult nature of raising money, you can see how raising a venture fund usually requires a solid base of already interested investors, connections to people with deep pockets, and the wherewithall to withstand the scrutiny and criticism for your endeavor. I have not even discussed the requirements of operational experience, investment experience, and previous fund trackrecord, nor have I discussed the different types of requirements that may be placed on you by various institutional investors. These topics and more will come later.
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