There’s no way around it: the venture capital landscape is changing.
While the fundraising process itself has largely remained the same, how investors and fund managers are securing capital has shifted dramatically over the last couple of years.
Previously, in the era of low interest rates and closing fast deals with ‘growth at all cost’ startups, raising funds was relatively straightforward. But fast forward to 2024 and the amount of VC funds raised is projected to drop 54% year-over-year. It’s clear that simply having a fund isn’t enough to pique investor interest.
Keep reading as we dive into the details of the VC fundraising process and how relationship intelligence might just be the key to successfully securing your next fundraising round.
What is a venture capital fund?
A venture capital (VC) fund invests cash in high-potential, early-stage companies. It’s a type of private equity (PE) that primarily focuses its efforts on startups in industry-disrupting spaces, such as technology. While the models are similar, traditional PE typically provides cash infusions to established companies.
But VC funds don’t just provide investors with a vehicle for investment into high-potential companies. They also play a significant role in driving economic growth and innovation. In many cases, entrepreneurs who have ideas don’t have the cash flow to bootstrap or meaningfully grow their businesses. VC funds provide them with capital so they can scale their company in exchange for an equity stake.
Unlike a traditional loan, venture capital doesn’t focus on long-term growth. Rather VC funds tend to aim to help founders and startups scale as quickly as quickly as possible—in hopes of generating a fruitful liquidity event.
The unique nature of venture capital also means that VCs often don’t simply invest in their portfolio companies. They use their own expertise and network to support these companies to drive results and increase the likelihood of return on their investment.
How do venture capitalists raise money?
Venture capitalists typically don’t use their own money to invest in companies. Rather they open a VC fund and turn to other sources of capital to flow money into their investments.
VCs raise money from:
- High-net-worth individuals (HNWI) or family offices: These are wealthy individuals or families with a lot of money to invest. VCs offer a high-risk, high-reward option for these HNWIs to diversify their investment portfolio and support causes that they are passionate about.
- Institutional investors: These are organizations that invest money on behalf of others. For example, banks, pension funds, and insurance companies. While many of these institutions tend to have a relatively low tolerance for risk, they often carve out a portion of their funds to invest in investments with a higher potential for reward.
- Corporations: Large companies may invest surplus cash in VC funds or other types of investments in order to create an additional revenue stream.
- Other venture capitalists: VC funds may invest in other funds—often called VC funds of funds—to diversify their portfolio. It enables them to invest their capital into a higher number of deals than if they invested directly. High-net-worth VCs may also invest in other funds to diversify their own personal portfolios.
The role Limited Partners play in VC fundraising
Successful VC fundraising comes down to one thing: relationships.
On one end, VCs need to connect with the right founders and entrepreneurs so they get access to investment opportunities when the time is right. But on the other hand, they also need the cash to fund these investments, which is where Limited Partners (LPs) come in.
In the VC fundraising ecosystem, LPs are the individuals or entities that provide the capital for a VC fund.
As the name suggests, LPs usually play a very limited role in venture capital outside of providing the capital that they’ve committed to. They have certain voting rights within the partnership and can also access financial statements and other business details. Depending on the agreed-upon terms, LPs may also be eligible to become co-investors in ventures or take on an advisory role with some investments.
But typically, LPs leave the management of the fund and the decision-making up to the General Partner (GP)—typically a senior leader in a venture capital firm. The hands-off approach is why LPs often turn to established funds or those within their trusted network.
If the fund is successful, LPs will eventually be distributed funds as a return on their investment. Usually, this happens during a liquidity event—when a company IPOs, the invested company is acquired, or the fund's shares are bought out.
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The VC fundraising process
Before a VC fund can begin backing startups, a fundraising round needs to be completed in order to lock in LPs and secure funding.
Let’s look at some of the key steps involved in the VC fundraising process
1. Determine your fund’s purpose
There are over 4,000 VC firms in the U.S. alone and that number only continues to grow. The expanded competition in the space has made it more important than ever to identify a key differentiator for your fund. Just like a company searching for investments, VC funds need to identify a problem or area of opportunity for themselves. For example, one fund may be looking to expand innovation in the ecotech space or another may be trying to bolster investment in seed-stage startups. Identifying a clear purpose early on not only streamlines your deal sourcing strategy but attracts the right potential LPs and companies to your fund.
Most funds are built on the personal expertise and experience of the founding team. It gives the fund a competitive advantage, allowing them to better support their portfolio companies and maximize their impact—and returns. And because every fund should have its own distinct purpose, it’s common for VC firms to manage multiple funds, each with a unique value proposition.
2. Create a prospectus for your fund
A prospectus is a disclosure document outlining the details of the fund and the management strategy. It’s one of the key documents used when raising capital and is often required by security bodies to facilitate a transparent investment process.
Not only is a prospectus legally required in many jurisdictions, it helps clarify investment terms (similar to a term sheet), highlights differentiating factors, and establishes credibility in the fund.
3. Tap into your network
Your network is your most valuable asset when deal sourcing throughout the fundraising process. When you harness the power of your network, you not only fill your pipeline with potential LPs but you create a network of trusted advisors who can put your investment opportunities in front of their own networks.
It can take dozens—if not hundreds—of leads to secure even one commitment. And while cold leads can lead to closed deals, warm paths of introductions can close them up to 25% faster. You never know when you’ll uncover your next deal in your existing network.
4. Solicit contributions from investors
Once you have a network of potential investors and champions for your fund, you can then start to solicit the capital for your fund.
At this stage, you’ll negotiate fund terms with potential investors and secure commitments from investors.
5. Make it official with a contract
Once the details have been ironed out with your investors, the fund will enter a legal contract, known as a limited partners agreement (LPA), to close the deal.
This is an agreement between the GP and each LP that outlines the terms and responsibilities of the relationship, such as the terms of the agreement, management fees, and fundraising or investment periods.
6. Operationalize your fund
Throughout the fundraising process, fund managers should be putting operations plans in place to streamline fundraising and prepare to make investments.
This includes, but isn’t limited to:
- Securing software: The right tech stack can streamline deal sourcing and pipeline management. Common VC software includes VC-specific CRM for deal flow management, a virtual data room for the due diligence process, and capital management software for centralizing deal flow.
- Hiring service providers: This includes all the people, such as lawyers, auditors, and administrative staff who can help support and launch your fund.
- Creating communication channels: VC firms need to keep LPs and potential investors informed of investments and opportunities, as well as continue to nurture relationships with investors, startup founders, and portfolio companies.
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Best practices to help fund your VC firm
While many VC firms are still raising capital, the fundraising landscape has become increasingly challenging for fund managers.
Following several years of overfunded startups and significant drops in valuations, 2023 saw the lowest level of VC capital raised since 2015. And 2024 is shaping up to be even bleaker.
As the VC landscape recalibrates, many LPs have money tied up in portfolios that have yet to exit and investors are pulling back capital. But billions of dollars are still flowing through VC funds and into new investments. To capture this money, funds need to be more strategic with their fundraising efforts beyond just revamping pitch decks. Here are some best practices to help successfully raise a venture fund—even in a shaky market.
Build your network
In the world of venture capital, your network is a key indicator of success. But relationships aren’t built overnight.
In a tricky market, doubling down on your network can be the difference maker in being able to raise another round. Even if not actively raising money, it’s important to plant the seeds for future relationships. It gives you time to expand your network and develop those relationships—so you have a robust pipeline of warm leads for your next funding round.
Your network allows dealmakers to uncover hidden opportunities and exponentially increases access to lucrative opportunities. It’s also a path to industry insights from prospects and peers, helping your fund determine the right time to pursue your next round or discover ways to create value that attracts investors.
Every new connection—even if not the right fit for your raise—can extend the value of your network by uncovering new relationships or vouching for your fund in their own circle of potential LPs.
Understand your investment thesis
Your investment thesis is essentially your investment strategy. It’s a set of guidelines that helps you make investment decisions with confidence.
Having a strong investment thesis isn’t just about what companies your fund will invest in. It’s also a guidepost for LPs and investors to determine if your fund is the right fit for their investment goals and risk tolerance. A well-defined investment thesis shows prospective investors that you have a strong strategy to manage their capital and mitigate risks.
Have answers to the tough questions
The steep drop in distributions means that LPs are not just strapped for cash but also increasingly cautious with how they’re allocating capital.
While most LPs have some propensity for risk, it’s clear that they’re now evaluating decisions with a fine-tooth comb. Rather than snapping up every market opportunity, more LPs are completing their own due diligence and asking questions before making any concrete decisions.
Fund managers need to be ready for more scrutiny. If you’re unable to confidently answer any concerns about your fund or your investment strategy, it will further erode LP confidence in an already uncertain market.
Have a strong business plan
“For LPs who can still invest, there is a flight to established brand-name firms. VCs with great past performance are fundraising successfully while lower performing and newer VCs are struggling—and may not be able to raise another fund,” says Affinity CEO, Ray Zhou.
Larger, established firms can rely on a successful track record to drive trust in their funds. Smaller or first-time firms don’t have the same luxury.
It ultimately just comes down to showing investors that you have a data-backed strategy that can yield results. A strong business plan can establish credibility and prospective LPs peace of mind.
Get the most out of your connections
The capital for your fund may already exist in your firm’s network. You might just not know it yet.
Relationship intelligence technology allows fund managers to turn connections into closed deals by:
- Focusing on the right investors: Enriched data provides insight into who has invested in what funds and when to target lists of investors that match your fund strategy.
- Uncovering warm paths of introduction: With a complete history of everyone in your dealmaking network, you can identify a warm path of introduction to prospective LPs that can secure commitments faster.
- Nurturing your existing network: Easily share data and fund performance to keep communication lines open with prospects and key investors while making sure no relationship goes cold.
Make more informed investment decisions
Affinity’s relationship intelligence CRM helps VC firms drive more investments and efficiently manage deals. From closing your next raise to sourcing the next industry-disrupting startup, Affinity harnesses the power of relationship intelligence and automation to support every stage of the VC ecosystem.
See how Affinity can elevate your VC fundraising efforts.
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VC fundraising process FAQs
How does VC fundraising work?
Venture capital fundraising takes funds from investors and consolidates them into a VC fund. The fund managers then take this capital and invest it into high-growth potential companies. It’s common to see VC firms invest in startups at the Series A, Series B, or Series C stage. But it’s become more commonplace to see VC investments at other stages, including in seed funding rounds, bridge rounds, or even in more established companies.
How do firms raise financial capital?
VC firms raise financial capital by building relationships with third-party investors looking for a vehicle for investment. When they open a fund, they create a business plan and investment thesis to solicit funds from potential investors. That money is then invested in companies with the hope that they generate a profit for both the limited partners, as well as the fund itself.
Where do venture capitalists get their money from?
The funds in venture capital come from high-net-worth individuals, institutional investors, and any other entity that is willing to provide them with cash to put into high-risk, high-potential investments.
What is the best way to raise financial capital?
There are many ways to raise financial capital including through private equity or VC firms, traditional business loans, your personal network, or even crowdfunding. Each type of financial capital comes with different benefits and drawbacks.
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