Starting a VC Fund, Episode 1: Are You Truly, Deeply Motivated to Start a VC Fund?

Hi, I'm Patrick. I'm the founder of MindMaven and we're an executive coaching firm that focuses on helping VCs and other leaders gain about a day, a week in terms of productivity gains, and then use that time to invest into the network, into relationships, to generate high quality deal flow.

I'm Charles Hudson, the founder and managing partner of Precursor Ventures. We're an early stage venture capital fund that invests in 25 to 30 companies a year at the very early stage. And when I say very early stage, I mean that idea. Inception, pre revenue, pre traction, pre launch phase.

That's awesome. And we're here today to talk about what it takes to start a VC fund. And so Charles, why are we talking about that?

I feel like I've learned a lot starting Precursor and a lot of the lessons I've learned are things that I really want to share and that I do share with people a lot of times in one on one conversations. And I really wanted to take the time to record some of these thoughts because there's a lot of things I've learned along the way that I think can hopefully help people save time and have a more efficient fundraising process when they're starting their first fund.

So let's have a conversation about that. Right? And so the first question I would have for you is like, where does this conversation start? Whenever you have those.

Whenever I talk to people, I always try to focus on the first thing, which is, why are you starting this fund? And you know, sometimes I get really nice answers from people. I love entrepreneurship. I'm passionate about helping founders. Being an investor is my calling. And that's all great, but oftentimes I find if you're going to go through the trouble of starting a fund, there needs to be some deeper personal motivation as well. For some people, you know, they've been an investor at another fund and they want more autonomy or more control or, you know, they see a class of founders who aren't getting attention in the marketplace and they feel uniquely positioned to help those people. For some people, honestly, it's about making more money. They think they could make more money out on their own. I actually don't care what your personal motivation is, but I do think if you're going to be successful as a fund manager, you have to be honest with yourself about what it is that's motivating you and pushing you to go through the really difficult process of starting a new fund.

So when you say honest with yourself, you're saying you really have to get to the root of what truly motivates you. And because you're stepping into something.

That'S relatively big. Right. And you would argue you're probably going to say it's bigger than most people think. Why?

I think the process of starting a venture capital fund, it really does take a long time. Even if you're stepping out from an established platform, maybe you worked at a big name VC fund and you've got some connections, if you're that person, you're just in a different place. That's a very small sliver of people who start venture funds. For most people, starting a fund is a slog. It's going to take you a really long time.

How long?

So for me, it took me about two years to fully close our first fund. It took, depending on how you do the math, we talked to over 300 LPs. I can't tell you how many individual meetings, airplane flights, bad coffees it took to get the fund done, but it took a long time. So the rule of thumb I always use is you should plan for one year but budget for two. So what I don't want to have people have happen is you spend a year perfecting your pitch, getting to know LPs, and right as you're on the cusp of breaking through, right as you're the cusp of figuring out what resonates with LPs, you've run out of resources or you run out of energy, or you've run out of time or you've run out of LP leads.

Interesting. So basically you're saying two years before you are actually really capable of calling yourself a vc.

I think for most people it takes about two years to get that first fund put together. Along the way, you might have a first close. You might close some money, you might make some commitments to portfolio companies. But I think there is something really satisfying about closing your first fund. Once your first fund is closed, you are officially in business. Until your first fund is fully closed, you're kind of in business. Like you have some ability to write checks, but you're limited. The other thing I would say is that closing your first fund, it's a huge emotional milestone for most people. It means you made it, you got it done and you did something that very few people are able to achieve.

That's actually a really interesting point because one thing you said is you need to have enough Runway in terms of just time, a in resources and just willingness to invest that time. But there's an emotional toll that comes with it too. Not just the Happy emotional toll, the celebration when you actually got it done. But what do you need to expect on the way to that?

I. I think the emotional toll, it depends on the structure of your fund. So, for example, I started Precursor as a single partner. The benefit of that was there was no risk that our team would break up along the way. The downside is you go on this roller coaster alone. And when I talk about the roller coaster, you know, I had a stretch of 42 consecutive no's that weighs on you. At some point, it will cause you to question if this many smart people that I'm pitching are telling me no in the back of your mind. It's hard not to feel at some point, well, what if they're right? What if this is kind of a fool's errand? What if all the feedback I'm getting is actually a reflection of reality? And I think you need to have a way to pick yourself up when you're down like that. And for me, I had a cohort of other people where we all started our funds at roughly the same time. And for me, that was a really important support system and continues to be a really important support system for me. I think the other thing is, I tell every aspiring fund manager at various times, you will run out of patience, you will run out of. You will get close to running out of financial resources to support yourself. Most likely, unless you've really accumulated a big war chest, you will run out of hope, and you will run out of LP leads. And I find that all of those things are renewable. But, man, running out of LP leads really is the thing that's scary.

Okay, that's interesting. I want to ask you more about what it actually takes in terms of just like, financial resources to pull this off. But before I do that, I wanted to say, basically because of all of these things, the time it takes, the resources it takes, and the emotional toll it takes, you really want to be clear on your motivations, because if those motivations aren't in place, you most likely end up giving up prematurely.

Right.

And so you can basically waste a lot of time if you don't have that in place. So, yeah, talk to me about, like, money wise, what does it take?

Yeah, and before I go to money, there's one more point I want to emphasize, which is, as a single gp, I kind of only had to manage the mental state of one person myself. I didn't have to worry about, well, what's my partner? What's our partnership? How are people feeling?

Yeah.

And the number, the Reason I always come back to this, why are you starting your venture fund piece? And this timepiece is I've met a lot of two and three partner partnerships that start off together and they don't all have the same ability to stick it out. And along the way one person says, hey, you know, for family circumstances, we've been at this a year and we're not close to the number. I need to go get a job to go support my family. There is no shame in that. But I can tell you nothing will tank a fundraise like having a partnership slide that someone saw six months ago with three faces on it and suddenly there's two faces. And so I think it's really important that like as a group or whatever, your, the core unit is that you all have a shared agreement about why you're doing this and you also have a shared sense of timeline, how much you can endure before the fund closes. Cause I've, I've seen a number of partnerships and it seems to always happen at that 12 to 18 month mark, which is like right on the cusp of a breakthrough, someone has a breakdown.

Yes, of course. And the reason you're bringing this up is that one could argue that what you did or what you're doing is somewhat an outlier, not as standard.

Right.

Like a single GP setup isn't the norm. And so basically what I hear you say is like, besides your own motivation and clarity around that, make sure the people you basically doing this together with has the same, and has the same breadth in terms of time and emotional stamina.

All right, let's, let's get to the money thing.

I think the money thing is the part about this that almost nobody talks about because it's uncomfortable and I didn't fully appreciate it when I started precursor how important the money piece was. If you stop and think about it, most people who start venture funds, they're either on average, either already wealthy or have a good job beforehand. You're going to take all of that and you're going to press pause. Remember I said this process can take you two years from a budget standpoint. Let's talk about what happens. First of all, you can't really take a salary draw from your fund until you've had a first close and have management fees. So it's very possible that you will go a year without drawing a salary from your own venture fund. Second, until you have a first close in, the fund is sort of an entity. You can't really deduct or charge those expenses to the fund. So you're also going to eat travel. Depending on your relationship with your law firm, you might have to eat some legal fees. There's some, there's some setup costs, there's some production costs for your fund materials. This is not trivial. So you're going to go from, in many cases making a good salary that's going to go effectively to zero. And the out of pocket costs are going to, they're going to add up. In addition, you're going to have a general partner commitment to your fund that'll be on the low end, probably 1% of the total amount you raise. And someone once asked me, you know, what do you think it costs to get a venture fund off the ground? And my ballpark figures, it costs about a million dollars in hard assets. I'm not talking about foregone pay opportunity costs. I'm talking about actual ability to support yourself and your family and carry sort of the load minus what small salary you'll make on your presumably small first fund. I think you have to sort of gird yourself that in the first three to five years you might put a million dollars into the organization. Not all at once, but over time.

And you got to have that willingness to do so, which brings it back to the stamina and so forth. All right, what else do you tell people?

I think the other thing I tell people is, you know, starting a company is a journey, right? But as a founder you might decide to leave as your, maybe your co founder takes over the business, maybe you bring in a professional CEO. But startups have a, most startups have a finite lifetime. They will live and end. Occasionally you get a Microsoft or a Google or Salesforce, one of these companies that lasts a really long time. In techland, venture capital partnerships, generally speaking, last 10 years. So the day you decide to start.

A fund, wait, why 10 years? Because I think, right, a fund is usually seven years long.

Most seed, most early stage funds will have a 10 year life. Okay, so Precursor has a 10 year life. So every time we raise a new fund, mentally I tell myself I am signing up to do this work for another 10 years.

Basically, really we're not talking about 10 years, but 10 years plus because you raise the second fund probably relatively soon after the first one and so you easy up to 12 and then easily 14 and so on and so forth. And the further you want to go, every time you want to continue on something that you just built up, you are just re signing up for another 10 years.

And as the founder and managing partner of your own fund, you really. You shouldn't leave. It's not a. It's not the kind of business where you start it and you kind of get bored and you hand it off to someone else or you leave. Your LPs are counting on your time and attention on this for the life of the fund, basically.

There's no solid path to a nice exit strategy, huh?

Maybe when you get to a high roman numeral fund, 5, 6, 7, when you've got other partners who can transition out. But I would tell people that you should assume if you do well, you're going to be in it for five or six funds minimum.

Yes. And so you really want to know that you want to do it. Okay. I slowly but surely understand why you're harping on motivation so much. All right. I think one of the times when we talked about it, you said that basically a lot of people come first with that motivation of just like, wanting to do investments.

Right.

And wanting to be investors. What do you say to them?

I think one of the hardest things to learn about starting your own fund, like, I worked at another venture fund before Precursor, but I wasn't the managing partner, so there were large swaths of the business that I was not involved in. And one of the big things I tell people is if you're going to start a venture fund, you're really going to need to be good at three activities simultaneously. And we'll talk about ways to sort of scratch the fun part of the itch or the fun part, which is investing without starting a fund. But if you're going to go the fun route, you have to be good at three things. You have to be good at going out and pitching LPs and raising the money you need to stay in business. That is a skill. It's a fundraising skill. It's an activity that doesn't really impact. It doesn't positively impact your ability to support and help your companies. It's a necessary part of the job.

Yes.

Second, a venture capital fund is effectively a small professional services firm, like an accountancy or a law firm. You have bills, you have service providers, you have tax, you have audit. There's a whole, like, operational side of the business that is decidedly unsexy. But it's very important if you want to stay in business as a very good.

Is it easy to underestimate the effort that that part of the business takes?

I dramatically underestimated it when I started. And the problem is it compounds the more money and the more funds you have, because each of your funds has tax and audit that has to be done annually, has a K1 statement that has to be prepared for limited partners, has reporting requirements. These things stack on top of each other and it's very rare that you put on your calendar, I'm going to spend an hour on tax and audit. You just do it. You find the time for it. And it's a sort of creeping time commitment that grows over time that seems to trip everybody up in the beginning.

And causes extra stress and feels like a distraction from what you actually came to do. Right. And that is to fund in really awesome, preferably world changing type of.

Startups.

And the operations stuff, a lot of that stuff touches your LPs so you don't want them to lose confidence in you by not being able to get your quarterly financials out on time and not being able to get your K1's done.

And you can't mess around with that.

Right, you can't mess around with that.

So you got to do it really well because. Yes, all right, that makes a lot of sense. You have. What you're telling me is this pretty big unsexy part about that business that you have to actually make your core competency simply because it's part of the job. All right, good. But you mentioned something about other ways in which you could actually scratch that fun part, the investor itch as you call it. Love to hear some more thoughts on that.

I think the world has changed quite a bit. You know, when I started Inventure in the late 90s, there was no sort of idea of investing as a side project or as like part of a professional portfolio. It was either your job and you did it or maybe you were an angel investor who was retired, who wrote some small checks on the side. But for the most part you had to be a full fledged, full time member of a venture capital fund to really experience the job. And I think we the world has changed a lot. Now there are a lot of other ways to ease your way into becoming an investor without having to make the decision to start a fund. Like I think of like starting your own venture fund as the like most high commitment, high stress way to start. As a venture capitalist. It's. You're really locked into it. There's lots of other ways. Yeah.

Tell me about the others, what comes to mind?

Yeah, so I think.

In the environment you've got things like scout programs which if you're fortunate enough to get into one, gives you the ability to write small checks to companies that you think are interesting. Get used to the process of being an investor. Writing checks to founders, working with them, supporting them, being helpful, without the full time commitment and overhead of running a fund. I think we have angelus rolling funds now which enable you to sort of raise money on a rolling basis to invest in startups, which means, again, you can do that while doing other things. I have some friends who've become angels, and every day the bar for angel investing in terms of check size goes down. I've seen companies that will take angel investments at a thousand dollars each.

What? All right.

They'll bundle all those people together. And so I would just say, like, the starting a venture fund is really for people who are like, I am clear in my mind that I want to be a full time investor for the next 10 or 15 years. If that's. If you're not clear about that, I would encourage you to look at some of these other optional ways to try on the job of being an investor. Because the worst thing you can do is start a venture fund in two years and realize you don't like the job.

Yes. That sounds like hell to me. Not a place I would want anybody to be. All right. I think this was really awesome, Charles. This was a really cool rundown of some of the things you had thought of. I learned a lot and I hope everybody listening and watching did too.

This was great. Thank you.