March 21, 2023
7 min

The 3 crucial stages of the venture capital fundraising process

Fundraising is a complex and time-intensive process. While there is an abundance of advice on raising capital  for a startup, emerging fund managers face unique challenges that require a different set of strategies and considerations. 

The first thing you’ll need to find out as a budding fund manager is how exactly the  fundraising process unfolds. 

What are the different stages of the fundraising process? 

Join us as we explore the three fundamental stages of a venture capital fundraising process:

  • pre-offering, 
  • offering, 
  • and closing.

By the end of this blog post, you'll have a solid grasp of the intricacies involved and be well-equipped to navigate the challenges inherent in raising a private market fund.

The 3 stages of the fundraising process

During the pre-offering stage, fund managers lay the groundwork for their fundraising efforts. With a solid foundation in place, they move on to the offering stage, where they build a list of potential investors and engage in outreach activities. Finally, the closing stage is where investments are secured. 

Let’s go into more detail and find out what each fundraising step entails. 

Stage 1: The pre-offering stage

Before approaching investors, fund managers embark on the pre-offering stage, which sets the foundation for a successful fundraising process. This stage involves crucial strategic considerations, like defining the fund's strategy, determining its size, and overseeing meticulous planning.

Fund strategy, size, and planning

Defining the fund's strategy is the starting point of any  fundraising journey. At this stage, fund managers need to carefully outline their investment focus, target sectors, and geographic preferences. This strategic framework will later guide the fund's investment decisions and set the stage for attracting the right investors.

Determining the desired fund size is another vital aspect of the pre-offering stage. Fund managers assess the capital requirements for their investment strategy, taking into account factors such as operational costs, expected deal flow, and portfolio diversification. 

Risk management plays an important role, especially in Venture Capital. The VC Model is a numbers game which only works with dozens of investments. Having enough capital to invest in multiple companies and also protect your equity from dilution through follow-up investments requires meticulate planning. 

Alongside strategy and size, careful planning is essential for success. Fund managers need to consider various aspects, such as the timeline for fundraising, potential LP outreach strategies, and regulatory requirements. 

Setup of fund entities

The next step in the fundraising process is the setup of fund entities. This stage involves establishing the legal entities associated with the fund and ensuring compliance with regulatory requirements.

Fund managers need to navigate the legal landscape to establish appropriate entities for their fund. This typically involves working with legal professionals specialising in fund formation and securities law. The specific structure and entities you choose will vary depending on factors like the fund's jurisdiction and your preferences.

The setup process includes tasks such as drafting and filing legal documents, as well as the formation agreement and operating agreement. These documents outline the fund's organisational structure, governance, investment objectives, and other key provisions. Fund managers need to carefully consider the terms and conditions outlined in these agreements to align with their fund's strategy and protect the interests of the investors.

Creation of marketing and fund materials

In the offering stage of the fundraising process, fund managers need to effectively communicate their fund's value proposition and investment opportunity to potential investors. This involves creating essential marketing and fund materials that showcase the fund's potential and appeal to prospective limited partners (LPs).

Fund managers will need to develop a range of materials that provide key information about the fund and its investment strategy. These materials include:

  • Offering Materials: To outline the details of the fund's offering, including its investment thesis, target sectors, expected returns, and terms and conditions for investors. Offering materials serve as comprehensive guides that inform potential LPs about the investment opportunity and help them make informed decisions.
  • Private Placement Memorandum (PPM): A legal document that provides in-depth information about the fund's structure, investment strategy, risk factors, and terms. It serves as a disclosure document to potential investors, offering transparency and ensuring compliance with securities regulations.
  • Pitch Deck: A visually compelling presentation that highlights the fund's key features, investment strategy, team expertise, and potential returns. It is a powerful tool for fund managers to convey their value proposition and capture the attention of potential investors.

The creation of marketing and fund materials is not merely a matter of compiling information but also involves crafting compelling and informative content. Fund managers should focus on conveying their unique selling points, demonstrating their expertise in the target sectors, and highlighting the fund's competitive advantages.

Stage 2: The offering stage

Once the marketing and fund materials are ready, fund managers enter the offering stage, where they actively engage with potential limited partners (LPs) and seek to attract investor interest and commitments. This stage involves various approaches to identifying and researching potential LPs, as well as effective outreach strategies to connect with them.

Finding potential limited partners (LPs)

Fund managers need to identify and research potential LPs who align with their fund's investment strategy and are likely to be interested in the opportunity. Approaches to finding potential LPs often include:

  1. Research and networking: Conduct thorough research to identify institutional investors, family offices, high-net-worth individuals, and other potential LPs who have a track record of investing in private markets or are interested in the fund's target sectors. Network within the industry and leverage professional connections.
  1. Fundraising partners: Collaborate with fundraising partners such as fund law firms, placement agents, or fund administrators to their networks of potential LPs. These partners have extensive experience and relationships within the industry, so they can help you identify and connect with suitable LPs.
  1. Leveraging platforms and databases: Utilise online platforms and databases that specialise in connecting fund managers with potential investors. Industry-specific databases provide comprehensive information on institutional investors and family offices that may be interested in private market investments. Additionally, LinkedIn offers the opportunity to research and connect with individuals who fit the fund's target investor profile. 

Once potential LPs have been identified, fund managers need to execute effective outreach strategies to engage with them. A few best practices include:

  • Tailoring communication efforts to each potential LP, highlighting the fund's value proposition and explaining how their investment aligns with the fund's objectives. 
  • Participating in conferences, industry events, and networking gatherings where potential LPs may be present. 
  • Utilising online platforms, such as LinkedIn or dedicated investor networks, to share updates about the fund, engage in industry discussions, and connect with potential LPs. 

Fund managers can also leverage streamlined investor onboarding solutions like Vestlane to extend investment opportunities to smaller investors starting with amounts as low as $200k+ – this widens the pool of potential LPs and provides more flexibility in attracting a diverse range of investors.

Investor due diligence

Once potential limited partners (LPs) show interest, they typically conduct due diligence to evaluate the fund and the fund managers. 

Investor due diligence is a crucial process from the investor's perspective. Fund managers need to be prepared to address various questions and demonstrate deep expertise in order to instil confidence in potential LPs. Institutional investors manage pensions of potentially millions of people. Try to see it from their perspective and keep that in mind going into the due diligence process.

During the due diligence process, potential LPs can inquire about various aspects of the fund. Some common areas of interest include:

  • Fund structure: LPs might seek to understand the fund's legal structure, governance framework, and the terms and conditions governing the relationship between the fund and its investors.
  • Management team: Investors want to know more about the fund managers' experience, expertise, and track record. They might inquire about the team's investment philosophy, past successes, and ability to navigate challenging market conditions.
  • Pay structure: LPs can seek clarification on how the fund managers and employees are compensated. They might ask questions about management fees, carried interest (or profit sharing), and other financial arrangements.
  • Co-investors: Potential LPs often want to know who the other investors in the fund are. This information helps them assess the credibility of the fund and evaluate the alignment of interests among investors.
  • Investment strategy and expertise: LPs are particularly interested in understanding the fund's investment thesis, target sectors, and the specific opportunities the fund plans to pursue. 

A thorough evaluation of the fund and its managers is essential for potential LPs to make informed investment decisions. Investors want to ensure that the fund aligns with their investment goals, has a sound strategy, and is managed by a competent and trustworthy team. 

For fund managers, this stage of the process presents an opportunity to demonstrate their expertise and industry knowledge. It is crucial to provide clear and transparent answers to all investor inquiries, addressing concerns and providing comprehensive information that instils confidence in potential LPs.

Stage 3: The closing stage

As the fundraising process progresses, fund managers reach the closing stage, where partnerships with limited partners (LPs) are solidified. At this stage, LPs can make soft commitments, which play a crucial role in moving the fundraising process forward.

LPs' soft commitments

Soft commitments refer to indications of interest and intent to invest in the fund from potential LPs. These commitments are non-binding and serve as a preliminary signal of the LPs' intention to participate in the fund. They are typically made based on the information provided during the due diligence process and discussions with the fund managers.

Soft commitments are valuable for fund managers as they help gauge investor interest and secure initial indications of support. While not legally binding, they provide a level of confidence and assurance that LPs are interested in moving forward with the investment process. 

These soft commitments play a significant role in the closing stage, as they allow fund managers to assess the overall demand and investor sentiment. Fund managers often use soft commitments as a basis for further negotiations, discussions on terms and conditions, and finalising investment agreements. 

We recommend that fund managers maintain open lines of communication with potential LPs who have made soft commitments. It is essential to provide additional information, updates, and clarifications to solidify these commitments. Providing regular updates can also help to keep potential investors interested once the soft commitment is made, but don't keep LPs waiting for too long.

Terms sheet negotiations

During the closing stage of the fundraising process, fund managers and limited partners (LPs) engage in negotiations to finalise the key terms of the investment. The objective is to reach mutually agreeable terms that satisfy the interests of both parties, surrounding:

  • Management fee: The management fee is the fee charged by the fund managers to cover operational expenses and compensate for their services. Negotiations can focus on determining the appropriate percentage of the fund's capital committed as the management fee and the frequency of its payment.
  • Carried interest (carry): Carry refers to the share of the fund's profits that the fund managers receive after the LPs have received their initial investment back (often referred to as the hurdle rate) and a preferred return. Negotiations centre around the percentage of carried interest, the preferred return threshold, and the hurdle rate.
  • Clawback provisions: Clawback provisions protect the LPs by allowing the fund managers to return carried interest if the fund's performance does not meet certain thresholds. Negotiations may involve defining the conditions under which clawback provisions would be triggered and determining the mechanisms for calculating and implementing them.
  • Fund duration: The duration of the fund, also known as the fund's life, is another important term to negotiate. It determines the timeframe within which the fund managers are expected to invest the capital and realise returns for the LPs.

Reaching mutually agreeable terms is crucial for establishing a strong and collaborative partnership between the fund managers and the LPs. It ensures that the interests of both parties are aligned and creates a foundation for a successful investment relationship.

Negotiating key terms involves finding a balance between the fund managers' need for compensation and the LPs' desire for favourable returns and investor protection. Fund managers should approach negotiations with a focus on creating a win-win situation. You should aim to consider the expectations and objectives of the LPs while safeguarding the fund's financial sustainability, fund managers can foster a positive and cooperative relationship that supports the growth and success of the fund.

Investor onboarding – KYC & AML

As the fundraising process progresses towards the final closing, one crucial aspect that fund managers need to address is investor onboarding. Investor onboarding involves the process of gathering the necessary information and ensuring compliance with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations. 

KYC and AML compliance are critical components of investor onboarding. KYC regulations require fund managers to verify the identity and suitability of investors. AML regulations aim to detect and prevent the use of funds obtained through illegal means within the financial system.

Implementing robust KYC and AML compliance measures allows fund managers to demonstrate their commitment to maintaining a transparent and trustworthy investment environment. It helps protect the fund from potential risks and ensures compliance with regulatory obligations. Furthermore, KYC and AML compliance procedures provide additional safeguards for investors, promoting investor confidence and trust in the fund.

Efficient investor onboarding processes enable fund managers to streamline the collection and verification of investor information, ensuring compliance with KYC and AML regulations. 

With Vestlane, fund managers can leverage technology and automation to efficiently collect and verify investor information, reducing the administrative burden and ensuring a seamless onboarding experience for both the fund managers and the investors.

Vestlane's user-friendly interface allows fund managers to collect required documentation, conduct identity verification checks, and perform risk assessments in a secure and compliant manner. The platform integrates with relevant databases, ensuring the accuracy and validity of the information provided by investors. 

First close or initial close

As the fundraising process nears its conclusion, fund managers reach a significant milestone: the first close or initial close. This stage involves securing initial investments from limited partners (LPs) and marks a significant step towards achieving the desired fund size. Subsequent closes may follow, depending on the fundraising goals.

The first close demonstrates the confidence and commitment of the initial set of investors. It validates the fund's investment thesis, strategy, and value proposition, and serves as a positive signal to potential LPs who may be considering investing in the fund.

Final close

Depending on the fund's structure and fundraising strategy, subsequent closes may follow the initial close. The number and frequency of subsequent closes may vary based on the fund's investment strategy, target fund size, and investor demand. Once the final close is achieved, the fund is ready to enter the investment stage.

The transition to the investment stage represents an exciting phase for both the fund managers and the LPs. It signifies the beginning of the fund's primary purpose — to invest in and support high-potential companies, fostering innovation, and driving growth.

Takeaway: The fundraising process

In summary, the fundraising process shares similarities with a classic B2B sales process, but it is unique to each fund. Thorough planning, including setting aside ample time (often up to 18 months) and preparing contingency plans, is crucial for a successful fundraising journey. 

A well-executed fundraising process holds immense significance for the overall success of a fund, as it lays the foundation for securing partnerships with limited partners (LPs) and enables the fund to begin its investment activities.

To streamline and optimise the investor onboarding process, consider leveraging Vestlane. We offer a comprehensive platform that simplifies investor onboarding, ensuring compliance with KYC and AML regulations while providing a seamless experience for both fund managers and investors.

Now that you have a deeper understanding of the stages and key considerations in the venture capital fundraising process, you can navigate this complex journey with confidence, maximising your chances of attracting the right investors and driving the growth and success of your fund.

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