Venture Capital Fund Fundraising: A Comprehensive Analysis
- surajit bhowmick
- Sep 7
- 7 min read
We’re launching a series that will provide a step-by-step explanation of how a venture capital (VC) investment process unfolds, from the initial interaction to the final exit. We’ll break it down into detailed micro-steps, so you see the whole lifecycle and the logic behind each stage.
This is the first article of the series, Venture Capital Fund Fundraising: A Comprehensive Analysis.
Before you start, if you’re unfamiliar with the different funding stages of startups, then here is the article you need: Startup Funding Stages: From Friends & Family to IPO. Don’t forget to come back to deep dive into Venture Capital Fund Fundraising.
Define Fund Thesis
Strategic Foundation and Purpose
The very first step is to define the fund thesis, which acts as a document that defines how a venture capital fund will generate returns for its Limited Partners (LPs). Fund Thesis is a comprehensive investment roadmap that outlines the fund’s specific focus, target markets, and unique value proposition.
A well-crafted fund thesis typically follows a proven formula: "[Fund Name] is launching a [$x MM] [Stage] venture fund in [Country/City] to back [Geography] [Sector/Market Companies] [with Secret Sauce]". This 35-40 word structure has proven successful for over 60% of new venture capital firms.
Core Components of Fund Thesis Development
If you’re familiar with different stages of funding, then you can connect with this point easily; if not, here is the article. Funds must choose between early-stage (pre-seed, seed, Series A) or late-stage (Series B, C, and beyond) investing.
Early-stage investing involves higher risk but offers potential for exponential returns, with investments typically occurring at lower valuations during companies' formative years. Late-stage investing focuses on companies with established revenue streams and proven business models, offering more predictable returns with reduced risk.
Sector Focus strategy
Many successful funds concentrate on specific sectors such as fintech, biotech, SaaS, healthcare technology, or climate tech. Sector-focused venture capital allows firms to develop deep industry expertise, better assess market trends, and provide more valuable support to portfolio companies. This specialization enables funds to make more informed investment decisions by understanding regulatory environments, customer behavior, competitive landscapes, and technology cycles within their chosen sector.
Unique Value Proposition
I call it “Secret Sauce”; this differentiator should be quantifiable and based on concrete achievements such as investment exits, performance metrics, capital raised, or network size. The most compelling metrics include successful exits, investment performance, and a demonstrable track record in the target sector.
Thesis Development Process
Market Research and Validation: Fund managers must conduct a thorough analysis of their target market, identifying emerging trends, the competitive landscape, and investment opportunities. This research validates the thesis's assumptions and confirms market demand for the fund's proposed investment strategy.
Portfolio Construction Planning: The thesis should specify the fund's approach to diversification, including the number of portfolio companies, average check sizes, follow-on investment strategy, and capital allocation across different stages. This portfolio construction strategy directly impacts the fund's risk-return profile and determines how capital will be deployed over the fund's lifecycle.
Market the Fund to LPs
Let’s first understand who Limited Partners (LPs) and what they do.
Limited Partners encompass diverse investor types, including pension funds, family offices, sovereign wealth funds, high-net-worth individuals, university endowments, insurance companies, and corporate investors. Each LP category has distinct investment preferences, risk tolerances, and return expectations.
Since you are familiar with LPs now, let’s understand how VC firms pitch to LPs to raise a fund.
LP Pitch Deck Development
Essential Pitch Deck Components: A compelling LP pitch deck must include eight critical elements:
Fund Overview and Investment Thesis: Concise summary of the fund's unique value proposition, investment focus, and market opportunity.
Team Introduction: Detailed bios highlighting relevant experience, track record, and industry networks.
Market Analysis: Deep understanding of target market growth potential and competitive landscape.
Fund Strategy and Portfolio Construction: Explanation of deal sourcing, selection criteria, and risk management.
Track Record and Case Studies: Evidence of ability to generate returns through specific investment examples.
Financial Projections: Clear models for capital deployment, expected returns, and fund economics.
Value-Add Proposition: How the fund supports portfolio companies beyond capital.
Terms and Timeline: Summary of key terms, fees, carry structure, and fundraising milestones.
Fundraising Strategy and Process
Wave-Based Investor Approach: Successful fundraising employs a structured wave system rather than activating all potential LPs simultaneously. The first wave includes investors most likely to commit—those who already know, trust, or have existing relationships with the fund managers. The final wave targets the most prestigious but hardest-to-reach investors, by which time the fund has secured most of its capital and refined its pitch.
Networking and Relationship Building: Fund managers must leverage existing relationships, attend industry conferences, and seek warm introductions to potential LPs. The most effective connections occur through trusted sources rather than cold outreach. Successful fundraising requires building relationships before needing capital, positioning the fund within the startup ecosystem.
Demonstration of Market Conditions: Fund managers must provide robust data showing favourable macroeconomic conditions for startup success over the next 2-3 years. LPs understand that adverse economic conditions—high inflation, rising interest rates, increased unemployment—significantly impact startup performance.
Close Commitments
The Capital Commitment Structure
Pledge-and-Draw Model: Venture capital funds operate on a commitment-based structure where LPs pledge specific amounts of capital but don't transfer funds immediately. Instead, the General Partner issues capital calls when funds are needed for specific investments. This structure allows LPs to manage their capital more efficiently while ensuring the VC firm can access funds as needed.
Legal Documentation: Each LP's commitment is documented in subscription agreements and the Limited Partnership Agreement (LPA). These documents outline key details, including commitment amounts, capital call procedures, fee structures, and fund terms. LPs may also negotiate side letters that modify specific terms on a case-by-case basis.
Closing Process Mechanics
Staged Closing Approach: Funds typically close between 10-25% of their total target size in the first close, with the balance raised over two or three subsequent closings across 12-18 months. This staged approach allows funds to begin investing while continuing to raise capital.
Formal Closing Requirements: A fund closing occurs when investors sign the fund's subscription documents and the GP countersigns them. At this point, investors formalize their pledged capital commitment and become Limited Partners in the fund. The first closing generally takes place when sufficient target LPs have signed the LPA, after which the GP files the necessary regulatory paperwork and provides proper notice to LPs.
Initial Capital Call: Most fund managers immediately initiate a capital call requesting 20-30% of committed capital after the first close. This capital covers organisational expenses and enables initial investments aligned with the fund's thesis. The initial drawdown can vary widely depending on GP preferences and fund needs.
Capital Call Operations
Notice and Timing Structure: Capital calls are legally enforceable and follow the rules outlined in the LPA. GPs typically provide 10-15 business days' notice before funds are due, outlining the amount needed, purpose, and remaining commitment balance. Many managers provide rolling cash-flow forecasts or cap annual drawdowns to help investors plan liquidity.
Pro-Rata Distribution: Every capital call is taken proportionately from all LPs' unfunded commitments. For example, if an LP committed 10% of the total fund, they must contribute 10% of each capital call amount. LPAs typically include default penalties such as interest charges, dilution, or forced sale of commitment for non-compliance.
Set Fund Structure
Limited Partnership Framework
Legal Structure Foundation: Most venture capital funds operate as limited partnerships, a legal entity consisting of at least one General Partner (GP) and one Limited Partner (LP). This structure provides pass-through taxation benefits, where partners pay taxes on proceeds they receive rather than the fund paying corporate taxes.
GP Responsibilities and Liability: The General Partner manages the partnership's daily operations and has unlimited liability for the fund's business operations. GPs are responsible for all investment decisions, portfolio management, and fund operations, assuming full responsibility for any business debts or legal liabilities.
Fund Lifecycle and Duration
10-Year Closed-End Structure: Venture capital funds typically operate as closed-end funds with fixed 10-year terms. This structure matches the time startups need to mature from early-stage companies to exit-ready businesses. The 10-year timeline includes a 3-4 year investment period for deploying capital, followed by a 5-7 year harvest period for portfolio company maturation and exits.
Extension Provisions: Most funds include 2-3 year extension options if market conditions prevent optimal exit timing. Fund managers usually seek predetermined extension periods to allow smooth exits from all investments. Early termination is possible based on trigger events such as key person departures.
Capital Deployment Timeline: Fund managers typically deploy 60-70% of capital during the first 3-4 years, with 30-40% reserved for follow-on investments. This follow-on strategy distinguishes professional venture funds from angel investors and allows funds to support portfolio companies through multiple growth stages.
Economic Terms and Fee Structure
Management Fee Structure: GPs typically earn annual management fees of 2% of committed capital to cover operational costs, including salaries, office rent, and legal expenses. These fees provide a steady income during the fund's investment period, regardless of investment performance.
Carried Interest (Carry): GPs earn carried interest, typically 20% of profits after LPs receive their initial capital plus a specified return threshold (hurdle rate). This carry structure aligns GP interests with LP returns, as GPs only receive significant compensation when the fund generates strong returns.
Distribution Waterfall: The fund's distribution waterfall defines the economic relationship between GPs and LPs. This structure determines how proceeds are distributed, typically ensuring LPs receive their original capital plus preferred return before GPs receive carried interest.
This comprehensive fund structure creates a symbiotic relationship where LPs provide capital and GPs provide expertise, with aligned incentives for generating strong returns over the fund's lifecycle. The 10-year closed-end structure with commitment-based capital calls provides flexibility for both fund managers and investors while ensuring disciplined capital deployment.
Thank you for reading the article! I hope it gave you a clear understanding of how VCs raise funds for investment purposes. Now that we know how funds are raised, the next step is learning how these funds are deployed into companies for profit. In the upcoming article, we’ll explore how VC firms source deals (finding startups).
If you found this article useful, do share it with someone who might benefit, and don’t forget to leave a ❤️. If you’d like to support my work, you can even buy me a book [here].
Comments