How Does a Venture Capital Fund Work?

Are you about to start looking for investment from Venture Capital funds? If so, we recommend learning how they work and what they expect from you as a founder and potential investment. 

That’s why this article explains everything you should know about a Venture Capital fund to help you save time, money, and effort in your fundraising process.

Note: This video is not for investors or people interested in setting up a fund. It summarizes the most important things a startup should know about an investment fund and how it affects its fundraising strategy.

‍What is a venture capital fund?

Also known as Venture Capital (VC) funds, these are institutions that raise investment, manage it, and invest it exclusively in startups according to a specific thesis. Through various exit mechanisms, they aim to generate financial returns for their investors and fund managers.

‍Why create an investment fund?

• To make a positive economic, social, and/or environmental impact in a region or around the world by financially supporting startups that solve a problem.
• To generate financial returns for its investors and operators.
• Fun and a passion for technology and innovation.

‍What is a PPM (Private Placement Memorandum)? 

A Private Placement Memorandum (PPM) is a document that the managers of a prospective investment fund share with the investors from whom they are trying to raise the fund. It describes everything an investor needs to know to decide whether to invest in the fund. 

Some of the topics covered in this document, which is similar to a pitch deck, include:

• Fund size
• Minimum investment per investor
• Fund duration and periods
• Target returns
• Distribution of capital and returns
• Investment thesis
• Investment instruments
• Selection process
• Breakdown of fund-related costs and management fees
• Potential exit strategies
• Market opportunity
• Founding and operating team

A fund’s life cycle

As a founder, you can ask in the 1st meeting what stage the fund is at. This will help you determine whether the investor is currently making investments or is at another stage that may not be of interest to you. Remember, as a startup, you want to pitch to investors who are actively investing.

Investment thesis

An investor’s investment thesis is essentially a set of rules that determines the characteristics and conditions a startup must meet for the investor to invest in it. If any of these conditions are not met, or it is unclear whether they will be, the investor probably won’t invest. 

As a rule, we recommend that you always learn about a fund’s investment thesis before applying and scheduling a call. Explore the investment theses of more than 200 investors in our database of institutional investors for LATAM startups here. 

Some of the elements that make up an investor’s thesis include:

1. Minimum investment
2. Maximum investment
3. Follow-on investment
4. Investment geography
5. Industry
6. Technology
7. Business model
8. Stage 
9. Minimum traction
10. Product development stage
11. Team characteristics
12. Ability to lead a round or not
13. Legal entity

Legal structure of a VC fund

Traditional legal structure of a VC fund in LATAM

Note: This image does not represent the legal structure of every fund in Latin America. However, it serves as a guide to help your startup understand how money flows from the investor to your bank account. 

Expected returns for a VC

Expected performance of a portfolio of 10 investments

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Note: This image may not represent the standard for all investors. However, it serves as a guide to help your startup understand an investor’s expectations for their portfolio.

An investor’s selection process

In general, and in simple terms, here’s the process your startup would likely go through if an investor were to invest in it. For more details, we recommend watching the video.

1. Scouting
2. 1st screening
3. Call
4. Request for basic information
5. Investment committee
6. Preliminary agreement - term sheet
7. Due diligence
8. Signing
9. Capital call
10. Investment

Reasons why an investor might not invest

More than 98%, sometimes 99% of the startups that apply to an investment fund are rejected and do not receive investment. Some of the most common reasons for rejection are:

1. At least 40% of startups are rejected because of their stage
2. Traction
3. The investor doesn’t believe the team can do what it says it will do
4. Industry or technology
5. It is not a potential fund returner or unicorn
6. The team is not working full time on the project
7. There wasn’t a good fit with the team 
8. The founding team lacks a technical co-founder
9. The product has few barriers to entry
10. Geography
11. Small market
12. Too much dilution too early
13. Legal issues (intellectual property, among founders, employees, etc.)
14. Non-standard or fund-favorable round terms

Venture Capital funds invest in 1 or 2 startups out of every 150 that approach them. Do your homework and study their investment theses before spending too much time and effort on an investor who has no chance of investing in you.