Startup advisor and mentor Tzvete Doncheva shares more on where the money behind the money comes from and the current VC landscape in the latest (Re)StartUp Strategy series.

The interest in European tech is rapidly growing. As an example, a little over a decade ago, there were 13 tech companies with a valuation of more than $1billion in Europe. By 2019, the number increased by 13x.Their financing was historically not primarily done through venture capital. This has now changed.

One of the top-performing early-stage VC firms on the continent is Hoxton Ventures; its first fund having the highest ratio of unicorns to investments in Europe, according to Dealroom. Shortly after the announcement of their second fund, Hussein Kanji, a partner at the firm took part in an ‘Ecosystem Giants’ event of mine to share more on his journey in venture, fundraising and the early stage market in Europe.

“There is a lot more money, a lot more interest, a real financial capability that wasn’t there before. If you take a look at how much money went into European venture fifteen years ago to today, it’s changed almost by a factor of 10x or 20x. “

Indeed, VC investment in European startups has grown fourfold to €23bn (2013 to 2018). More capital, more opportunities and more new VC funds. The level of maturity of the VC ecosystem corresponds to the diversification of the LP/GP base. Public sector money still makes for a large amount of investments in venture funds, especially in the SEE/CEE region. 

One such public investor is Fund of Funds, a joint-stock company owned by the Bulgarian state, which implements in the country the financial instruments, co-financed by the European Structural and Investment Funds. The company manages a public resource of over € 660 million and implements a wide range of products for the financial sector, including guarantees, private equity and others.

“In a nutshell, our role in the process comprises of detailing the design of the respective fund, running a selection process with candidate fund managers, support the legal closing of the fund and manage the participation post signature as any LP would do. Given our specific role of a public investor we monitor the fund performance in other aspects as well, e.g. proper executing of the eligibility requirements for investees, following up state aid rules and so on. Technicalities aside, we always endeavor to fulfill the fundamental idea of the investment strategy of our mandate.The underlying notion is that if a team has a strong track record in tech or in growth investments it would most probably strive to replicate and to adopt an approach similar to their past success stories.” - says Martin Danovsky, Chairman of the Management Board of Fund of Funds.

Fund of Funds is the solo LP in one of the newest VC funds in the SEE region,  Vitosha Venture Partners.The General Partners, like Max Gurvits, hold the rest of the private equity in the fund company.

“We obtained the fund-of-funds investment by winning a public procurement procedure with the Bulgarian government.” - says Max.

He summarises the requirements to win as:

1. Investment strategy
2. The joint and separate experience of the managing partners
3. The price offer (management fee proposal)

Vitosha Venture Partners does not yet have a portfolio but is looking to make 130 investments over the next several years. 

“With such a high number of deals, we have the luxury to spread our bets far and wide, both across pre-seed, seed, and early-A stages, as well as across verticals and sectors ranging from biotech and SaaS, to e-commerce and FMCG.”

How does raising a VC fund differ to raising VC investment?

“Sourcing money from LPs for your own fund is 10 times harder than raising funding typically for your start-up” - says Alex Balderstone, Co-Founder at Kaiku, a platform that helps startups to source early stage funding and also Venture Director at Birmingham Enterprise Community Accelerator. He found it a natural progression to bridge his efforts into raising a fund. He admits his young age can be a challenge when meeting and building relationships with prospective limited partners however.”

“Whilst this is not unexpected, the same issue lies when a young founder (who is unproven) is trying to raise for their own company and inevitably this factor has to be made to be seen more as an advantage rather than a burden.”

If you are in a similar position, focus on why your age is a benefit more than a liability - whether it is dealflow access, an understanding of Gen-Z/Millennials thinking or finding outlier companies through scouts. 

Another big barrier to starting a venture fund is the cost associated with the set up itself.

“It is expensive which is a huge barrier to entry for people from low income backgrounds as fund managers also have to invest in the fund.” – says Charmaine Hayden, Partner, GOODsoil VC, a diverse early stage venture capital firm investing in under-represented exceptional founders. The firm’s target first close is £50million by Q2 2021.

“Historically, a good track record has been needed to get a VC fund up and running. With this the costs can be prohibitive, especially if you’re going through the traditional route of setting up through lawyers.”- agrees Alex.

It is not uncommon for partners at established VC firms to split off and form their own. Elizabeth Yin(General Partner, Hustle Fund), who previously ran the Mountain View accelerator as Partner at 500 Startups, shares her tips on raising a $11.5m VC fund here.

Of course, it is a time-consuming process. For Max Gurvits, it took nearly three years - from the moment the original tender was announced (September 2017) to winning in 2019, and finally structuring/launching the fund in 2020. 

“What I’ve learned is patience. My main motivation for going for this opportunity (twice) is that after a decade of experience on both sides of the table, I am convinced that VC in a market like Bulgaria and CEE can only be successful if you have a fund investor that’s committed not only to profitability, but also to community building.”

In the current environment where almost all meetings are virtual, the process is likely to take even longer than the anticipated time (from months to years). Not all fundraises are successful - many fail to raise the target amount or to close an institutional investment. Unless the fundraising process has been made public, failures are mostly only known in the community. Ankit Arora, who previously worked at Accel and Unilazer Ventures, shares his reflections on failing to raise a VC fund and tips for emerging managers here.

Jonathan Hollis, Managing Partner at Mountside Ventures, a company that optimises the fundraising process for European start-ups and investors, regularly interacts with prospective and current LPs. He says the biggest red flags for Limited Partners are when fund managers: "Do not stick to their investment thesis, exaggerate or misrepresent their track records, do not understand that the fundraising process is a longer relationship-building exercise and they are not going to get a yes on the first couple of meetings.”

It is a relationship-driven industry and similarly to the point made in a previous (Re)Startup Strategy article, trust and integrity are vital and take time to form. If a partnership between an entrepreneur and a VC fund is intended to be for years, with limited partners, it is for decades. Having a strong network and personal referrals carry a lot of weight when raising institutional capital - not having direct access to prospective limited partners is a big obstacle.

In any startup pitch, the topic of competition comes up. Similarly, the new fund managers who raise successfully are the ones able to differentiate themselves by addressing the ‘why you’ question and the opportunity they are going after. This has been signalled out as especially important for those who have not previously managed institutional capital. Over communicating to (current or future) stakeholders in moments of uncertainty is also paramount. 

In meetings, other factors LPs assess are the return potential(3x-5x for early stage funds) and the portfolio construction strategy. This post on Kauffman Fellows (written by Hilary Cook, Sapphire Partners) is a must-read guide for emerging managers who are fundraising - it highlights questions you may get asked and defines the key 4 Ps of success as patience, persistence, being persuasive and pragmatic.

On securing a public investment, Martin insists every management team is welcome to participate in Fund of Funds’ selection process. 

“We are always ready to welcome first-time managers as well, particularly with respect to early stage funds. While we are delighted to partner with some of the most respectable and established names in the country, we have also entrusted certain participations to teams with limited fund management track record.”

He also explains less experienced teams often underestimate “the added complexity in modus operandi of a fund backed by a public investor”. Especially, when coupled with uncertainty.

“The public funds come with an additional layer of strict rules, eligibility requirements, control environment and so on. As some of these are ultimately driven by policy objectives they might not come as immediately intuitive notions for professionals with pure financial or venture background. In result, such teams may overestimate their plans to execute efficiently the intended investments in a timely manner.”

Democratising access to venture capital

Different, leaner methods of raising capital have also been launched. AngelList is a financial platform for the venture industry, with the aim to ‘increase the number of successful startups in the world.’ It introduced Rolling Venture Funds earlier this year to further their mission, allowing managers to raise/accept capital in the form of auto-renewing quarterly commitments. Through this structure, fund-managers (to be) are able to publicly market their fund - with some closing in a matter of weeks. One such example is Gumroad founder Sahil Lavingia, who raised a $5m rolling fund with a Notion memo, a Zoom call with close to 2K registrants and a few tweets (he does have over 130K followers!). Others like Kate Brodock and Allyson Kapin (The W Fund) are shifting to this from a traditional fund model. The flexibility that comes with it would allow them to invest in startups straight away and continuously increase the fund size. 

Alex agreed: “We are currently operating as a rolling fund and this has definitely become a more interesting and flexible way of fundraising in the last few years. What is great with this process is that a certain fund size does not have to be set and it allows you to grow (if things go well!) Above all the process allows barriers to fundraising to be lowered and not only just allows for fractions of a fund to be raised, but also for investing to be commenced right away from inception. Beyond this continuous fundraising can always continue thus meaning additional funds never have to be raised again.”

Rolling funds may lower the barriers to fundraising and remove the friction managers experience in the process but on their own can’t solve the diversity issues in venture capital and in tech. Charmaine shares there are a lot of biases that still exist: “Many LPs view the diversity conversation as a philanthropic/ HR issue rather than a genuine business case.”

So how can the level of diversity be improved? Charmaine helps to set out the following suggestions.

1) Become aware of biases - to accept, understand and explore

“I would make all LPs take the Harvard social bias test as most of us believe that because we do not have malicious thoughts about other social groups that we are not biased.”

2) Impose minimum allocation rules into diverse fund managers

“Making all fund managers including LPs understand that they have a fiduciary responsibility to be the best stewards of capital and to do so they need to be less rigid in their approaches in order to find the very best deals for great returns.”

3) Create more opportunities for open communication

“Giving diverse fund managers a seat at the table so that they(LPs) can build warm rapport and understand the thesis behind the colour or gender bias.”

4) Top-down – inspire the change you are advocating for

“Fund managers can encourage their portfolio companies to hire more staff that reflect the population and thus the founders and customers that they wish to serve.”

And finally, what developments should we expect to see in the LP ecosystem? According to Jonathan, Coronavirus has not led to an overall investment freeze(as was the case in 2001). 

 “Many of the larger institutional limited partners aren't significantly slowing down their allocations into venture, although some are doubling down on their highest performing funds who have experience dealing with recessions, and others are being more careful to stay in their commitment plans.” 

Questions VCs can ask LPs to better understand where they stand are:

1. Are you actively making investments in venture?
2. If yes, how many will go to existing/vs new fund managers?

In the UK, Coronavirus is not the only source of uncertainty. 

“Naturally, the impacts of Brexit remain uncertain and institutions such as the EIB which have historically backed several UK based funds rests in the balance with more of our interest now looking overseas to other EU jurisdictions.” - concludes Alex.

Every three weeks, the (Re)StartUp Strategy series with Tzvete Doncheva will offer insights from the VC world, bringing you a step closer in your fundraising journey. What would you like to know on investor readiness, positioning and overall growth? Stay up to date with her by subscribing to her newsletter on tech news, early stage fundraising and venture capital here.