As a GP, courting LPs can be a very ambiguous process. You might go in with the full range of optimism and skepticism. Regardless, if you haven’t done the inner work of evaluating yourself, your partnership, and your fund strategy with exceptional detail, you may not have the clarity needed to build the most compelling narrative to win LPs.
We connected with Jaclyn Hester, Principal at Foundry Group–a VC firm that invests in early-stage tech companies and venture funds–to dive into the hard questions that GPs are often unprepared for, but should be able to answer.
In addition to working on direct investments, Jaclyn has helped build Foundry’s partner fund portfolio of 32 early-stage VCs and leads on their emerging manager strategy. She’s reviewed over 400 VC funds and has spent countless hours meeting with new managers. Her goal is to help emerging managers tell their stories better, refine the core tenets that really matter, and give real feedback.
“Fundraising is story-telling. Emerging managers often struggle with building a compelling narrative that makes LPs want to dig in and learn more” says Jaclyn. ”Your job in the first meeting is to get a second meeting.”
A major component of understanding whether a VC will attract capital and talent (i.e. great founders) is the team’s ability to tell their story. Explaining how a fund is differentiated can be a tricky task and it takes some brutal self-awareness of your fund’s and your team’s value proposition.
“You need to be able to articulate what a [insert name of your fund] deal looks like” notes Jaclyn. “This is easier said than done. Few managers do it well. It’s important messaging, not only for potential LPs, but also for the market: Why will founders, friends, co-investors, etc. send a deal your way? What gets you excited? How do you help companies?” Managers can think of this as market positioning, which is ever more important in a market flooded with venture funds, especially in the micro-fund and emerging manager categories.”
We asked Jaclyn what she focuses on when evaluating potential fund investments.
“Really, it’s all about the people, especially for emerging managers who don’t necessarily have an established track record. LPs are looking for talented, dynamic individuals that will attract talented founders, who will, in turn, attract talented operators to help build their companies. Networks, therefore, are incredibly important and managers should expect LPs to dig in on that front.”
“Really, it’s all about the people, especially for emerging managers who don’t necessarily have an established track record.
“It’s also important to note that LPs are building portfolios of managers, just like you’re building a portfolio of companies, so diversification is a key consideration. Foundry, for example, is a network-driven investor and looks to partner with firms that are accretive to our portfolio network.”
In evaluating a manager, LPs are thinking about the job of a VC: e.g. sourcing, picking, winning, and helping. A few questions LPs might ask are:
- Do you have interesting and unique deal flow?
- Do you have a thoughtful and differentiated point of view or thesis?
- Do you have a strong reputation for treating founders well and being able to add value?
- Are you an expert in a certain industry or business model?
- Are you able to win deals in a competitive market?
- Does the portfolio construction make sense for the strategy? Do you have sufficient bandwidth to support the strategy? How do you get leverage?
- How will this be at least a 3-5x fund?
Beyond the “jobs” listed above, fund management and company building are key to a successful venture firm. According to Jaclyn, there are a few extremely important questions that managers often don’t have an answer for, but should:
- How do you make decisions? What process does the team undertake in vetting a deal? Do you take a vote? Does everyone have to be excited and all-in or just supportive?
- What are the economics amongst partners and other investment team members? Who owns the management company?
- How are you thinking about firm-building? What do you want to be? How do you think about fund size and the team over the next few funds?
- How do you fire each other or decide to end it?
Before even getting to the LP questions mentioned above, those starting a firm should also be asking themselves some hard questions (ones LPs will be thinking about if you decide to take the plunge):
- If you’re coming from an operator background, do you have any investment experience? Have you ever written a big check with “OPM” (Other People’s Money)? Will you miss operating?
- Do you know how venture funds work? – formation, structure, economics, etc. Are you prepared to make no money for a while during the launch/fundraising stage?
- Do you have mentors that will help you understand things like portfolio construction, fund management, and investor relations?
- Are you comfortable with a REALLY long feedback loop? You probably won’t know if you’re any good at this for at least 5 years, if not 10! (Many would argue longer).
LPs will certainly have a lot of questions, but “GPs should ask LPs questions too,” comments Jaclyn. “It’s a great way to understand their venture profile. Ask about some of the funds they’ve invested with. Do they do co-investments? What size check do they typically write and do they expect this to increase in future funds? What does their process look like?” Jaclyn also mentioned that turnover in LP land, especially at the institutional level, is to be expected, so it’s always good to have at least two points of contact at a given organization.
Ultimately, by exploring the hard questions of venture capital, you’ll help your organization develop a clear narrative and a compelling story for LPs. You won’t be a fit for every LP, and that’s okay. Be true to your values and vision and play to your strengths.
Remember that LPs are your partners, not opposing parties in a transaction, so be prepared to build meaningful relationships and take a long-term view.