Early-stage micro-fund VC 101: What Investors, Founders, and Scouts Should Know
For several reasons, limited partners (LPs), founders, and scouts must understand how early-stage micro-fund venture capital (VC) works. Understanding VC will help LPs make informed investment decisions. It will help founders secure funding for their startups. And it will help scouts identify promising startups for potential investment. You’re in luck because we’ll tell you everything you need to know about early-stage micro-fund VC in this post. So let’s get started with this 101.
What’s an early-stage micro VC fund?
VC is a type of investment that provides capital to startups in exchange for equity (or notes that will later convert into equity). Venture capitalists, or “VCs,” invest in these companies with the goal of generating a return (lots of money) on their investment through the eventual exit (i.e., sale of their equity), which can include the sale or IPO of a startup.
Early-stage micro-funds raise up to $25 million and usually invest relatively small amounts of money into startups in the pre-seed and seed stages. For example, a $10 million micro-fund would usually put between $25,000 and $500,000 into each of the startups in its portfolio. And micro-funds get the money to invest in these companies from LPs, who can be high-net-worth individuals, family offices, or institutions.
Who do VC funds raise money from?
Traditional and large VC funds fundraise from institutional investors, such as pension funds and endowments. These investors are typically large organizations with significant financial resources, and they provide large checks to venture capital funds. Typically, institutional investors do not invest in micro-funds.
Micro-funds led by emerging managers tend to raise capital from high-net-worth individuals and family offices. These investors are typically wealthy individuals or families with significant assets and are often interested in investing in venture capital to diversify their portfolios and access high-growth opportunities.
What are the economics of a fund?
The economics of VC funds are structured in such a way that a fund typically receives a management fee (usually 2% of the total raised, per year, so the total over 10 years would be 20% of the total raised) for overseeing the fund’s operations and a carried interest (usually 20% of the fund’s profits) for generating returns for LPs. This means that if a fund generates a 50% return, the General Partners (GPs) of the fund would receive 20% of the fund’s profits (i.e., 10% of the amount raised) as carried interest.
For example, let’s say a $10 million micro-fund has the usual 2% annual fee and 20% carry structure. They will get $200,000 a year to run the fund (i.e., to cover fund expenses, including salaries). And if the fund produces $50 million in returns, it would give the initial $10 million invested back to their LPs, and from the $40 million left, 80% would go to LPs, and 20% would go to the fund.
What are the costs of a fund?
VC fund expenses include the cost of back-office operations, legal, talent acquisition, accounting and audit, and salaries for the fund’s team. Given the limited budget of a $10 million micro-fund, the fund managers would need to carefully manage these expenses to maximize their returns for LPs.
Are VCs rich?
Traditional VCs have always been wealthy, but not because they ran a VC fund. Most traditional VCs were already rich because their families were wealthy before they got into VC (unless you grew up with wealth, you might have never even heard of VC or considered it a career option).
By contrast, emerging VCs are not necessarily rich or making a lot of money. While very large VC funds can afford to pay salaries to their teams and partners of $150k+ depending on their title and experience, micro VC funds have much smaller budgets to work with. Regardless of fund size, VCs may become rich from investing in successful companies and accumulating wealth through the carry earned in their fund.
Consider that many underestimated and underrepresented emerging micro-fund managers are not rich and are likely making less than $100K a year, after expenses.
How long do VC funds operate?
Most venture capital funds have a 10-year plan. Between 2 and 4 of those years are spent putting the money they got from LPs into new businesses. The rest of the time is spent managing and supporting the investments in startups and starting to raise money for the next fund.
What are the jobs a VC fund needs to do?
A VC fund’s job is to find, choose, and invest in high-potential companies. After investing, the firm also helps the companies grow. Most of the time, this process involves finding promising start-ups, doing due diligence to figure out how successful they could be, negotiating the terms of the investment, and giving the companies ongoing help to help them grow and succeed. This help can come in many forms, like giving strategic advice and putting the company in touch with possible partners or customers or helping the company get more money from other investors.
Is there bias in venture capital?
Yes. Both LPs and VCs are more likely to invest in companies founded by people who are similar to them. This can make it hard for startups from underrepresented groups to get funding and make it hard for those groups to be represented among VCs.
Does bias make it hard for women of color VC fund emerging managers to fundraise?
Yes. Even though research has shown that diverse teams perform better than ones that are all the same, women and women of color still face bias and discrimination in the VC industry. A 2020 report from All Raise says that only 7% of senior investment positions at VC firms are held by women, and only 2% of VC firms are led by women. Black women only make up 1% of partner-level roles at VC firms, and Latina women only make up 2% of VC partners. This lack of representation can make it hard for women of color to raise money since LPs may be more likely to invest in companies that look like them (typically white and cis-gendered).
Is it a good idea to invest in and work with micro-funds led by underestimated and underrepresented fund managers?
Yes. Micro-funds can be helpful to founders, LPs, and scouts in a number of ways. When founders are backed by a micro-fund, they usually get more personal and hands-on support. If founders are underestimated and underrepresented, they will also have an investor who understands the personal challenges that come with the territory and can help them through those challenges. For LPs, investing in micro-funds can be a way to diversify their portfolio of investments and learn about a wider range of startups and founders. This can also give the chance for higher returns, since micro-funds may be able to invest in startups at an earlier stage than larger venture capital firms. LPs who invest in underrepresented fund managers will also have access to startups to which the typical Silicon Valley fund does not have access (because their check writers are not diverse). And finally, scouts who work with early-stage micro-funds led by underrepresented fund managers will gain valuable hands-on experience, career growth opportunities, and exposure to a wide range of startups and industries.
Overall, early-stage VC micro-funds can provide opportunities for both founders, LPs, and scouts, despite the potential biases in the venture capital industry.
Disclaimer: The views above should not be taken as financial or legal advice. Please do your own research before making any financial and legal decisions.
About Ganas Ventures: Ganas Ventures invests in pre-seed and seed community-driven startups in the US and Latin America. To learn more visit us at ganas.vc.
About Lolita Taub: As a Latina emerging manager and general partner at Ganas Ventures, I always want to work with or invest in community-driven founders, funders, and friends. I have a strong track record with 15 years of experience in the Silicon Valley ecosystem. I have sold over $70 million in tech products and services, made over 90 investments as an angel investor and venture capitalist with Backstage Capital, Lightspeed, and The Community Fund, and had 3 successful exits from my portfolio.
Forbes, Inc Magazine, Nasdaq, and others acknowledge my efforts in advocating investment in underestimated and undervalued founders. I completed my undergraduate studies at the University of Southern California and earned my MBA from the IE Business School.
In addition to my professional accomplishments, I am a dedicated community builder with more than 78,000 founders, funders, and ecosystem friends. And I want to back founders who care about the community, invite LPs into the Ganas Ventures family, and build wealth in the community that will last for generations.