Venture capital isn't for the faint of heart. You can't just cash out of an investment in a startup the way you do a stock. Many of the businesses you'll fund won't be profitable yet, and it can take several years for you to make a profit. Once you've got a successful "exit" behind you and the startup you helped finance goes public in an IPO, for instance, return percentages can reach double digits. Expect the unexpected, but some tools of the trade will help you get started.
Before starting your own venture capital firm, you may want to gain experience at another firm. It's not unusual for VC professionals to break off from their employer to start their own firms only after they've gained experience and built relationships. The qualities you gain as a partner or employee can be invaluable to success later on. After all, the experience, knowledge and relationships that you build on the job are equally as important as the capital and good reputation that you'll need to go it alone.
In addition to your own capital, you'll need limited partners, or LPs, to finance the startup businesses you want to help grow. The average early stage VC deal size in 2012 was $1.1 million, according to data firm Preqin. To get the capital and build a track record, explain the VC fund's investment strategy, risks and expected returns to potential limited partners such as pension fund managers, charities, endowments and wealthy individuals.
Understand that you'll be up against some tough odds. The number of new venture capital firms in the U.S. was on the decline between 2011 and 2013, falling from 100 to 56. More than half of your competition will have earned their MBAs from schools such as Harvard or Stanford, according to a 2013 article in Venture Beat. And there's no guarantee you'll get those returns you were expecting. More than half of venture capital-backed startup businesses don't succeed, according to a 2012 article in The Wall Street Journal.
Once the capital is secured, you'll need to find the startups you want to finance. A common mistake venture capitalists make is to expect startups to come knocking on their door. Instead, the burden is on you to identify profitable opportunities and then spend time with the business owners to build trust on both sides. Don't be afraid to use social media to help you do this. You should have new deals waiting in the wings to keep the returns coming.
- Entrepreneur: What It's Like to Launch Your Own VC Firm
- Preqin: Average Venture Capital Deal Sizes Globally in 2012 – December 2012
- The Wall Street Journal: The Venture Capital Secret: 3 Out of 4 Start-Ups Fail
- Cambridge Associates: Private Equity Distributions Hit an All-Time High in 2013, and Venture Capital Produced Its Highest Annual Return in 15 Years, According to Cambridge Associates Benchmarks
- The Wall Street Journal: Boulder, Colo., Most Popular City for Tech Startups, Study Says
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