Start a Venture Fund Without Being Rich

For a long time, the ability to become a venture capitalist was closely tied to one’s financial standing. It was generally understood that individuals needed substantial personal wealth to participate. Investors in venture funds traditionally required fund managers to demonstrate significant personal investment – often referred to as “skin in the game” – before committing capital. This typically involved a contribution of 2% to 3% of the fund’s total assets, frequently amounting to millions of dollars.

Indeed, five years ago, it was observed that financial constraints posed a greater barrier to entry into venture capital than gender inequality. This observation highlighted the challenges faced by women, who statistically earn less and possess fewer assets, particularly women of color. However, this obstacle extends to anyone with limited financial resources.

Fortunately, the landscape is evolving, with increasing opportunities for aspiring VCs to secure the necessary initial capital commitment. While none of these methods guarantee success in fund creation, they represent viable strategies employed by other VCs and are worth careful consideration.

First, seek out limited partners who are open to accepting a commitment of less than 2% or 3%, and potentially even below 1% of the fund’s target size. It’s likely that the number of potential investors will decrease as the required commitment shrinks. However, Joanna Rupp, who oversees a $1.1 billion private equity portfolio for the University of Chicago’s endowment, indicates that she and other managers she knows are willing to be adaptable based on the “specific circumstances of the GP.”

Rupp explains, “While industry ‘norms’ exist, we haven’t always mandated a commitment from newer GPs when we believe they lack the necessary financial means.”

Bob Raynard, founder of the fund administration firm Standish Management, shares this perspective, noting that a reduced general partner commitment coupled with favorable investor terms is a common practice. “A lower management fee for the LP, reduced carry, or a combination of both, has been utilized for years.”

Investigate management fee offsets, which are frequently considered reasonable by investors in venture funds. Michael Kim of Cendana Capital, a firm with investments in numerous seed-stage funds, points out that these offsets also offer potential tax benefits (although the IRS has considered eliminating them).

Here’s how they function: If your required commitment is $1 million over a 10-year fund lifecycle, you could offset up to 80% of that amount, contributing $200,000 initially while reducing your management fees proportionally over time to effectively cover the full $1 million. This essentially converts fee income into the required investment.

Leverage your existing portfolio companies as a form of security. Kim notes that several respected managers have launched funds by offering ownership stakes in startups they previously funded as angel investors, rather than making a traditional commitment.

In these instances, Kim benefited from rapid increases in the value of the companies. For the fund managers, it eliminated the need to contribute additional personal funds.

If possible, secure an agreement with financially secure friends. When Kim established his fund of funds to invest in venture managers after his time as a VC, he raised $1 million in working capital from six friends to launch the initiative. This funding provided Kim, who had a mortgage and a young family, with a two-year financial runway. While your friends must be willing to take a risk, offering incentives can be helpful. Kim, for example, granted his friends a share of Cendana’s earnings in perpetuity.

Explore the possibility of obtaining a bank loan. Rupp expresses reservations about GPs funding their commitment through bank loans, citing the inherent risk of fund performance and the potential for premature liquidation of successful investments.

However, Raynard notes that loans are not uncommon. He states that banks with venture capital relationships, such as Silicon Valley Bank and First Republic, are generally willing to provide fund managers with a line of credit to facilitate capital calls, provided there is a diverse investor base. “Banks are more comfortable proceeding if there’s a diverse group of LPs,” he suggests, as it increases the likelihood of securing their business.

Consider the advantages of “front loading”. This is a strategy that “more innovative LPs can sometimes accept,” according to Kim. It’s also the method used by investor Chris Sacca, now a billionaire, when he initially entered fund management. This approach involves blending the annual management fee of 2.5% of assets under management and allocating a higher percentage – for example, 5% – during the fund’s first three years, ultimately resulting in no management fee by the fund’s conclusion.

This could mean a period without income until investment profits materialize. However, it’s anticipated – particularly given recent trends – that the general partner will have secured funding for another fund by that point, providing alternative resources.

These are just a few of the available options. Lo Toney of Plexo Capital – like Cendana Capital – which invests in many venture funds, points out other potential paths. These include utilizing a self-directed IRA to finance the GP commitment or selling a portion of the management company or a larger share of your carry to generate funds for the commitment. (VCs Charles Hudson of Precursor Ventures and Eva Ho of Fika Ventures advised against this approach if possible.)

Ultimately, Toney, a former partner with Alphabet’s venture arm, GV, emphasizes that there is no single correct method for raising a fund and that employing these strategies carries no inherent disadvantage.

Toney stated via email this week: “I haven’t found any evidence to suggest that wealth is an indicator of future success in a VC’s career.”