Venture Capital Fund Strategy — Developing Investment Themes and Target Businesses.

6 min readOct 10, 2018

One of the key considerations in starting a Venture Capital (VC) fund is developing a strategy around how you’ll deploy your fund’s capital in order to maximise returns to your investors. Below are some factors to consider in establishing your investment themes and criteria for pattern-matching target businesses.

Portfolio Construction

Give some thought to basic fund maths upfront to understand the framework your fund must operate within to return value to your investors.

General portfolio strategy —Every venture firm needs to place enough bets to expose themselves to outsized successful companies (ie a unicorn or black swan). One option is to make lots of bets to increase your chances of finding good companies, another is to pick fewer investments but spend more time helping these companies to succeed. Either way it’s widely accepted the majority of a VC fund’s return will be generated by a small number of companies in the portfolio. This has been referred to as the Babe Ruth effect. Fred Wilson‘s target batting average is “1/3, 1/3, 1/3” (1/3 — expect to lose entire investment, 1/3 — expect to get money back or make a small return, 1/3 — expect to generate the bulk of returns).
Diversification — When considering the initial investment set, Seth Levine says the earlier stage the fund invests, the less concentrated it should be (larger distribution of outcomes), additionally, the smaller the fund, the less concentrated it should be (larger distribution and then concentrate on the clear winners).
Cheque size — Based on the thinking you’ve done above, how many deals do you expect to do from the fund in total. Give thought to what percentage you will reserve for follow ons as well.
Deployment period/ investment horizon — How many years have you got to deploy the full amount of capital from first cheques to follow on. Typically the management fee will reduce on the same schedule as deployment of all first cheques is completed (3–5 years depending on fund size), when will you return capital (bear in mind deals completed towards the end of deployment will have shorter period to return). Consider the amount of time required by the types and stages of companies that you plan to invest in.
Expected returns —What are you aiming for in your fund’s returns (standard 3x net return for 10 year VC fund), does every deal need to have at least 10x potential for consideration, will you set aside a percentage for the higher risk/ higher reward deals (eg 80x potential). Benchmarking against Australian data — Blackbird’s 2013 fund has an annual net internal rate of return of 58 per cent and a net multiple of 4.51 times. Carthona’s recorded a per annum internal rate of return of 98.1 per cent since February 2014.
Investor requirements — What do your Limited Partners (LPs) expect from their investment. Returns are an obvious start but give thought to things like value-alignment or off-limits categories (eg gambling, defence). A corporate venture fund is likely have specific categories they want to invest (eg a bank focusing on the customer ecosystem around fintech).

Assessment / Suitability for your fund

What are the strengths in your team that give your fund its unfair advantages.

Deal assessment — Do you have enough knowledge in particular areas to assess each investment opportunity’s potential for success. If not, will you be able to up-skill or hire in. Pattern matching your inbound deal flow will make for an easier assessment process (eg simple criteria for assessment — team, addressable market size, scalability, timing, unique advantages). Check out CB Insight’s ‘unicorn tracker’ and see if these are the kind of companies you could invest in if they came through your pipeline.
Value add potential — What are your fund’s areas of expertise to provide added value to the company down the track.
Leveraging networks — Network effect is a powerful phenomenon. Can you use this to your advantage in your fund eg by investing in companies that can help one another. Blackbird VC does this particularly well in AU. What are your deepest networks (co-investors, users, partnerships, talent acquisition) that could give your fund an advantage.

Target Businesses

What types of companies will your fund invest in and how will you attract them into your pipeline.

Company stage — Total capital + diversification plan + any prerequisites on the stake you need to take in the company, should guide you on the total round size that your fund should participate in. Obviously you should play to your strengths here too — what stage are you most comfortable assessing companies. I like to see businesses with early signs of traction in product/ market/ revenue. Most funds in the AU market focus around series A and follow on from there. Whereas the seed and pre-seed segments tend to be served most often by angels and accelerators.
Business model — Most funds in AU prefer a near-term revenue / profit mentality. This makes hardware and most deep tech businesses much less appealing.
Management team — What is important in founding team, eg I like smart, hungry, entrepreneurs with a 2–3 founder team (combined skills covering as much of tech, creative, business as possible).
Market size — Is the market big enough, is the segment growing fast enough. Is there tons of money already in the space. Is it overfunded/ over populated.
Exit track — For your investment to return, there needs to be some kind of exit. This could be a follow on investment you don’t participate in, an IPO, buyout or acquisition. This is likely to come up with LPs as they are focused on where the returns will come from.
Themes — Your investment themes could be based off any number of things eg. domain expertise, trends/ opportunities, history of success in particular categories. Bear in mind that Australia and NZ are not yet mature markets, so there might not be a depth of quality companies in particular segments. This is why many funds in our region have broader themes. Narrowing your pipeline by focussing too heavily on themes may jeopardise the overall quality of the companies you invest in.
Some of the successful themes in AU have been; SaaS, prosumer tools, and marketplaces.
Deal flow — LPs will want to see your plan for creating proprietary deal flow (i.e. companies to invest in). Some strategies in the AU market eg. a unique thesis like Blackbird’s ‘science non-fiction’ venture fund, domain expertise and access to corporate partner advantages like Reinventure’s corporate venture fund, or creating a solid network of co-investor partners to follow alongside deal by deal.

Outside Factors and Constraints

What are the outside forces able to influence your fund’s chances of success.

Trend / opportunity — There may be a trend you can see playing out that your fund is in the right place and right time to maximise. Eg. in AU Main Sequence Ventures is targeting one of Australia’s most valuable and under-served opportunities to back the commercialisation of deep tech companies.
Geography — Consider things like currency risks, foreign tax implications (for you and for LPs) and your portfolio management preference (how active you plan to be as investor (eg do you want to take a board seat in another country) should factor into this.
Regulatory — Be aware of the regulatory conditions applicable to your fund’s structure and region. Eg the ESVCLP (Early Stage Venture Capital Limited Partnership) is a popular framework in AU due to tax benefits but has conditions around things like total amount of capital that may be allocated to foreign domiciled investments.

Benefits of a clear strategy

Setting a clear strategy will be required for when you go to raise capital but it will also give your fund:

boundaries so everyone on the team knows what to spend time on
pattern matching criteria for your inbound deal flow allowing for an easier assessment process
the opportunity to maximise network effect and become the ‘go-to’ of your specialty areas

With new funds announcing in AU / NZ every few weeks, there are a lot of entrepreneurs figuring this information out as they go. Curious to hear more tips on what to think about — and I’ll add to the post as they come up.