5 questions emerging managers should ask before selecting LPs

When most people think of venture capitalists, they often think of investors, the people writing checks to fund startups. But that image is only one part of venture capital. In order to make those investments, venture firms must first have the money, which means they’re not only just the funders, they’re fundraisers, too.

But when you’re running a VC firm, especially as an emerging manager, how do you know which investors and limited partners (LPs) to target?

After more than 30 years of investing in both private and public companies, I’ve now started as a fund manager, and I recommend that emerging managers ask these five questions before seeking out and pitching to potential LPs.

Which LPs are you targeting?

To find the right investors, you first need to consider LPs’ investment criteria.

Institutional investors usually look for managers with a 10-year track record and at least three funds under their belt. These investors can also be hesitant to bet on emerging managers, whom they may perceive as higher risk than established investors, even though Cambridge Associates data shows emerging firms made up 72% of the top returning firms between 2004 and 2016.

Each step up the decision-making ladder increases the risk of dismissal, lost information or miscommunication, which can be mitigated if you can get in front of the decision-makers early on.

Managers who are stepping out on their own after working with an existing fund, meanwhile, can target fund of funds (FOF) since the FOF will use their track record as a prior employee as a proxy for standalone experience. Emerging managers can also target niche investors: for example, if you’re investing in education, a like-minded foundation might be a potential LP, or if you’re investing in medical technologies, you might try to connect with hospitals that could benefit from those innovations.

After launching Avestria in 2019, we found that family offices and high-net-worth individuals were the best targets for us. Their investment requirements aren’t as stringent as institutional investors or FOFs’, and they’re willing to accept the risk of investing in an emerging manager in exchange for potentially high financial returns.

How well do your target LPs understand your investment thesis?

Emerging managers should find out how well their potential investors already understand the unmet need your fund is addressing.

The venture capital community has significant influence on what potential LPs see as great investment opportunities. As a result, capital can be concentrated in certain areas. For example, Juul, a male-founded e-cigarette company, received $10 billion more in funding in 2018 than female-founded companies received collectively that year. In 2020, now-defunct video platform Quibi alone raised almost 8% of the total funding that female founders got that year.

Our fund focuses on female-led life sciences and women’s health startups, and it’s sometimes hard to rope in LPs who have the most exposure to headline-making investment sectors like consumer goods or media platforms. We often have to explain the white space: Women of child-bearing age weren’t allowed to participate in clinical trials, even for products meant for women, until 1993. Even 30 years later, only 4% of all healthcare research and development is meant to address women’s health issues. When my partner and I were first pitching, we found the LPs most likely to invest were those who understood the financial and personal benefits of investing in a fund like ours and were already aligned with our investment thesis and focus. Women, in particular, had usually experienced the disadvantages of being a female entrepreneur in healthcare, a female patient, or both, and recognized the need for change.

Are you close to the investment decision-maker?

Each step up the decision-making ladder increases the risk of dismissal, lost information or miscommunication, which can be mitigated if you can get in front of the decision-makers early on.

At our fund, despite their interest in women’s health innovations, we found that women usually don’t make the investment decisions in their families. They are less likely to control family financial decisions and less likely to risk investing with an emerging manager than men are, so we also reached out to potential male investors.

Some of these investors already understood the disparities in gender-based healthcare. Others, though, couldn’t believe that this glaring unmet need exists. After talking to many such potential investors, we realized they still weren’t likely to invest in us right away, especially if they were only the gatekeeper and would have to go up their investment decision-making pipeline and explain what we do and why it is needed.

Do your target LPs understand VC investment?

When looking for LPs, emerging managers should also look for investors who understand the venture capital industry and aren’t bringing their retail trading expectations to their venture capital investment.

Unlike retail traders, who have immediate feedback as stocks go up and down, VC investors don’t get daily benchmarks. VC portfolio companies might not see a markup for three or four years and might not see an exit event, like an acquisition or IPO, for 10 years or more.

As a fund investing in healthcare, we need our LPs to understand that the timeline is likely longer for our investments. For example, before products can be sold commercially, most of our portfolio companies must complete pivotal trials and submissions to the Food and Drug Association (FDA). Companies in other sectors don’t have such rules and regulations or such extended timelines.

We’ve been fortunate, though. We have already seen a few exits that happened rather quickly for the healthcare industry. When talking to both current and potential LPs, we’ve needed to ensure that they understand that those exits, despite being great markers of success, were exceptions to the standard exit timeline.

What other resources can your LPs provide?

Between accounting, deal sourcing, due diligence, fundraising and recruiting, starting your own fund can be a huge endeavor. As an emerging manager, your resources may be limited. The right LPs can fill those gaps by bringing resources beyond just the money to help your fund and portfolio companies.

Our LPs with experience or connections in healthcare have provided us with networks, partnerships and warm leads both for our companies and for us as we fundraise. After all, your existing investors can be your best advocates. Our LPs have also helped with due diligence and deal sourcing. In fact, nearly 70% of our 19 collective portfolio companies have come via our LPs and industry colleagues.

While capital contributions are essential to the health of a fund, LPs can be more than investors: They can provide resources to ease the strain emerging managers may face when starting a fund.

As an emerging manager without a long track record or multiple funds’ worth of experience, LPs are investing in you and your investment thesis. All VCs that raise funds know well that no pitch to an LP guarantees an investment, so use the criteria outlined above to find the investors most likely to believe in you.