by Brian DeChesare Comments (6)

How to Start a Venture Capital Firm – and Why You Probably Shouldn’t

How to Start a Venture Capital Firm

I noticed the other day that we had articles about how to start a private equity firm and how to start a hedge fund but nothing on venture capital.

But just like superhero movies, career advice works best when it’s a trilogy – so we’ll complete this trilogy with how to start a venture capital firm.

Starting a venture capital firm is less of a bad idea than starting a PE firm or hedge fund, but it’s still not a great idea for most people.

The biggest issue is that venture capital is best at the end of your career, not the beginning or middle.

The second biggest issue is that there are many ways to invest in startups and growth companies these days, so hardly anyone “needs” to start a VC firm to do it.

And if you think starting your own VC firm is “easy money,” please stop reading this article and seek psychiatric help immediately:

What is Venture Capital?

This article assumes you already know what venture capital is, how to get into venture capital, venture capital careers, VC interview questions, etc.

If you don’t know these points, please read this coverage first because I’m not re-explaining them.

Many of the requirements for starting a VC firm are similar to the ones for starting a PE firm, so I will focus on the differences here.

Why Do You Really Want to Start a Venture Capital Firm?

The other day, a friend forwarded me this tweet from Pieter Levels on X (Twitter):

How to Start a Venture Capital Firm - Tweet

I agree with his general point that there’s a lot of BS in the VC/startup ecosystem, with many people claiming “fake successes.”

However, he’s wrong about the specifics, from the management fees to the way carried interest works, but we’ll get to that later in this article.

I’m highlighting his tweet because it illustrates how many people think about starting a VC firm: You sit back, listen to startup pitches, pick the winners, and make millions of dollars as mermaids serve you piña coladas on a tropical island.

Nothing could be further from the truth.

Venture capital is a tough business, and it’s a high-paying, cushy job only for people who entered the industry decades ago and have advanced to the top.

OK, So Who Can Start a Venture Capital Firm?

There are exactly two types of candidates with a good background for starting a VC firm:

  1. Experienced professional VCs at the Principal, MD, or Partner level with solid investment track records, good relationships with Limited Partners, and unique insights into specific industries, geographies, or deal types.
  2. Successful startup founders with a solid history of angel investments who understand startups’ operational and financial sides.

Startup founders tend to be weaker with “LP relationships” but stronger with “building and supporting startups,” while it’s the reverse for professional VCs.

This is why it’s best to have at least one Partner when starting your fund – you want someone who can complement your strengths and offset your weaknesses.

If you do not fall into one of these categories, it is unlikely that you will be able to raise enough capital to start a substantial VC fund.

How to Start a Venture Capital Firm, Part 1: Raising Capital

It is still difficult to raise capital, but it’s easier than PE/HF fundraising because you need less to start a venture capital firm.

So, you don’t necessarily need to focus on institutions capable of writing very large checks, such as pensions, endowments, or funds of funds.

It’s easier to get meetings and quick responses from LPs such as high-net-worth (HNW) individuals and smaller family offices, so this is good news.

Before doing anything else, you must decide on your fund size and team size, which depend on your strategy and the number of portfolio companies you plan to invest in.

To keep things simple, let’s assume that you want a portfolio of 25 startups and you plan to invest in seed rounds for an average of $2 million per startup.

These will be software startups that need less initial capital than hardware, energy, or biotech startups.

So, you’ll need 25 * $2 million = $50 million in committed capital.

Assuming you charge a 2% management fee, that is $1 million in annual fees to cover overhead, salaries, and other expenses…. which is not that much.

After paying for rent, accounting, legal, IT, compliance, etc., that amount might cover:

  • Two Partners (yourself and someone else) who both earn compensation well below market rates, such as in the low hundreds of thousands per year.
  • One Associate to do the grunt work. This person will also earn well below market rates.

You might now say, “Wait a minute. If there’s not enough money to go around, why not raise a larger fund, such as a $100 or $200 million fund?”

The short answer is that raising $100 – $200 million as a first-time VC with a limited track record is very difficult.

According to Carta, even back in the frothy markets of 2021, the median first-time VC fund size was just above $10 million. Only 8% of new funds had $50 million or more:

Median First-Time VC Fund Size

But let’s assume that you’re OK with all of this, including the smaller fund size and the limited fee pool to cover overhead and salaries.

To raise this $50 million in capital, you’ll need the following:

  • Team: It is usually a bad idea to start a VC fund with only one Partner (yourself). You usually want at least two Partners, even for a $50 million fund, and you should have a history of working together.
  • Startup Investment Track Record: Speaking of track records, you must show evidence of successful startup investments, such as a few exits at decent multiples (5 – 10x+) over the years. If you don’t have this, work at an established VC firm or do your own angel investing until you do.
  • Highly Specific Strategy: The market is so flooded with VCs now that it’s not enough to say you’ll invest in “vertical SaaS” or “AI-enabled services.” You need to be much more specific regarding geography, strategy, sub-vertical, and more.
  • Sourcing Methods and “Access”: The returns in venture capital are very skewed toward the tiny number of companies that hit it big, which means that sourcing is critical. You need to be plugged into the startup ecosystem to find these companies, and all potential LPs will ask about your access to the best deals.
  • Personal Contribution to the Fund: Limited Partners will expect you to contribute 2 – 3% of the total capital, so if you and your Partner are not comfortable writing a check for $1.0 – $1.5 million for this $50 million fund, you should reconsider your plans.

The number of LPs varies, but according to the Carta data, most first-time funds have between 51 and 100.

That translates into a lot of meetings with family offices, wealthy people, and institutions; if you assume a success rate of 10%, you’ll need hundreds of meetings to win the commitments for your first VC fund.

You might be able to reduce the required meetings by focusing on groups that can write larger checks, but it will also be harder to get commitments from them.

How to Start a Venture Capital Firm, Part 2: Paperwork and Legal Structure

Much of this is the same as the paperwork and legal structure required to start a PE firm, so I won’t repeat everything here.

Funds are Limited Partnerships or Limited Liability Firms, and the firm is structured as a Limited Liability Company (LLC); a separate LLC is also formed for the General Partners in each fund.

You’ll need all the usual documents, such as the Limited Partnership Agreement, the Offering Memorandum, the Compliance and Risk Guidelines, etc., and you’ll need to spell out the management and performance fees, the hurdle rate (if applicable), your investment targets, and your distribution policy for the LPs.

The paperwork may be simpler for small VC firms than PE firms due to the smaller deal sizes, less capital, and lack of control over portfolio companies.

So, you might be able to finish everything for reduced legal fees, though it still won’t be “cheap” – perhaps a few hundred thousand rather than $1 million+.

How to Start a Venture Capital Firm, Part 3: Hiring a Team

If you’re raising a “micro” VC fund, such as one with $1 – 5 million in capital, the team will consist of yourself.

A management fee of 2% * $5 million = $100K per year barely covers overhead, so it’s not enough to hire employees.

For something like a $50 million fund, as in this example, the team might consist of yourself, another General Partner, and maybe a junior employee.

For a much bigger fund, such as a $200 million one, it might consist of 3 Partners and 5 – 6 junior employees (and everyone will still earn below-market rates).

The most important points in team composition are access to good deal flow and Limited Partner relationships.

The “classic” split allows one Partner to focus on fundraising and LP relationships and the other on sourcing.

If you have three Partners, the third might focus on operations for portfolio companies.

LP relationships are especially important in VC because it can take 10, 12, or even 15+ years to exit certain portfolio companies, so you’ll need to raise another fund based on preliminary results from your current fund.

You must convince the LPs to take a “leap of faith” based on your first few years, including significant unrealized gains on your top investments.

The LPs (should) understand the nature of startup investing, but it can still be an uphill battle, especially with less experienced individuals or family offices.

The rest of the team doesn’t matter that much for a first-time VC fund.

You want Associates and staffers who understand your industry and the basics of VC deals, such as cap tables, SAFEs vs. convertible notes, etc., but specific technical skills are less important than in PE because early-stage deals are simple.

Because of your limited fee pool, you may have to recruit “non-traditional candidates” to fill these roles, i.e., you won’t be picking from IB Analysts in the Goldman Sachs TMT group.

Instead, you’ll have to look for career changers who might be interested in VC, such as product managers at tech companies or professionals in business development, corporate finance, or related roles.

How to Start a Venture Capital Firm, Part 4: Surviving, Investing, and Growing

You are not just “investing” within your new VC fund but also running a small business.

That means the usual headaches with HR issues, audit/finance/tax/legal issues, brand representation/PR, portfolio companies, and LP complaints.

On balance, HR and employee issues are smaller factors here because team sizes are smaller.

But portfolio company issues and LP relations will take up more time.

Portfolio companies will consume more time because early-stage startups are always several steps away from death and need help with sales, marketing, recruiting, engineering, and more.

Also, a $200 million VC fund will have more portfolio companies than a $200 million PE firm because each deal is smaller, and VCs must invest in dozens of startups to have a solid chance at a single “home run.”

LP relations are tricky because of the issues discussed above: The exit time frame is long, you need to “sell” your next fund based on preliminary results, and you may be dealing with HNW individuals who don’t understand these issues.

How to Start a Venture Capital Firm, Part 5: Realistic Compensation

Given the time, effort, and money required to raise a single VC fund, you might be wondering about the realistic compensation.

Continuing with this $50 million VC fund example, let’s say that you and your Partner contribute $1.5 million total to the fund ($750K each).

With the assumptions above, you might earn a base salary of $250K per year.

After taxes in a place like California, this might be ~$160K per year, so you’ll need almost 5 years to earn back your initial contribution before even factoring in living expenses.

Also, this 2% management fee will scale down after the first ~5 years; the total fees over 10 years of a VC fund are usually ~15% of the committed capital, or $7.5 million here.

The bottom line is that for a single new VC fund, your salary from management fees mostly just covers your contribution to the fund.

The real upside from VC investing comes from the 20% performance fees (carried interest) if your portfolio companies do well.

So, let’s say that your fund performs well and returns $120 million over 10 years for a 2.8x multiple on the $42.5 million of invested capital (deducting the $7.5 million in total management fees).

Before you earn anything, the LPs must first earn back their full $50 million (yes, they are repaid for both the management fees and the invested capital).

The remaining amount is then split 80/20 between the LPs and you, so you earn 20% * ($120 – $50) = $14 million.

This is split between you and your Partner, so you each earn $7 million over this period (again, assuming the base salary just covers your living expenses and personal contribution).

That sounds great, but remember the following:

  • This was over an effective 12-year period if you account for the time spent setting up the firm and doing the initial fundraising, so it’s more like ~$583K per year for you.
  • Most VC funds, especially first-time funds, do not earn a 2.8x multiple—the average multiple is closer to 2x (source). Plenty of funds do not even return 1x, so the GPs earn nothing!

So, the optimistic case for a single $50 million startup VC fund is earning a net amount in the mid-six figures on an annualized basis; the realistic case (2x multiple) is earning ~$300K per year annualized.

This is not great annual compensation for senior-level professionals, so raising additional, larger funds is the usual solution.

This works if you keep posting solid investment results and have the resources and skills to raise funds.

If not, you can always find a new job after a few years of the VC game… which leads us into the final point here:

How to Start a Venture Capital Firm, Part 6: Exit Opportunities

The good news is that if your startup VC firm does not work out, you have more options than someone whose PE firm or hedge fund did not work out.

You could easily join a startup in a finance/fundraising role, go to a tech company in a finance role, or join a larger, established VC firm.

You will probably not be able to “try again” if your firm failed due to poor performance, but if you wait long enough, there may be exceptions.

And if you want to keep investing in startups, you can do so via angel investments, syndicates, or within a larger VC firm.

Final Thoughts: Does It Ever Make Sense to Start a Venture Capital Firm?

The previous articles on starting a private equity firm and hedge fund attracted many negative comments, as readers accused me of being too pessimistic.

But I stand by my comments that starting your own firm is not a great idea for most professionals in these industries – although there are cases where it can work out well.

With startup venture capital firms, the problem is different: There are now so many ways to invest in startups that you don’t “need” to launch a VC fund to do it.

In my opinion, it does not make sense to put in the time and effort of launching a “micro” VC fund with $5 or $10 million in capital.

It’s too difficult to operate with a fee pool that low, and you’ll have more upside by joining an established firm.

Starting a VC firm makes sense in two main cases:

  1. You have a long track record at an established VC firm, and now you want to branch off with your team and do something new because of disagreements about strategy or economics at your existing firm.
  2. You don’t “need” the money and are doing it for other reasons, such as wanting to launch new startups or advise them after a successful track record in executive roles.

Alternatives to Starting Your Own VC Firm

If your goal is to “invest in startups,” “advise startups,” or “earn money by working with startups,” there are dozens of alternatives that make more sense than starting a VC firm:

  • Start angel investing via sites like Angel List to build a track record with small amounts of capital.
  • Invest in a VC fund as a Limited Partner.
  • Invest in startups as part of a syndicate, either in real life or via online groups.
  • Become a startup advisor or “fractional employee” and help with financing and fundraising in exchange for small equity grants.
  • Join an established VC firm and work on sourcing, due diligence, and operations.
  • Work at a fund of funds that invests in VC funds and makes occasional co-investments.

The point is that starting a VC fund is like a hammer, and not every problem is a nail.

If you cannot clearly articulate why you want to start a VC fund rather than pursue one of the alternatives above, you need to reconsider your plans.

And please, do not start a VC fund because you think you’ll earn $2.5 million in management fees “forever” in exchange for no work.

About the Author

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.

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  1. What do you think of going to work at a start up VC? For context, I’m a non-target in IB in a niche group that’s not known for exits.

    1. You could do it, but it’s worse than normal VC in terms of skill set / exits unless you just want to stick to the VC / startup ecosystem. On the other hand, if the firm performs really well and they’re more open to promotions, you might be able to advance quickly. So it is a bit of a gamble and could work out very well in some cases if you stick with it, but could also end not so well (the more likely outcome). At least with an established VC firm, you get some brand name/reputation benefit. Going to a startup VC removes those benefits and adds new risks. So I don’t recommend it in most cases unless it really is your best exit option.

  2. Lol make it a 4-movie saga — do starting an M&A boutique next!

    1. For some reason, we get almost no questions about starting a boutique M&A bank, probably because people realize it’s not fun or easy.

  3. Russ Hanneimann should’ve read this article

    1. To be fair, I am 100% fine with billionaires wasting millions / tens of millions on their personal VC funds that fail.

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