The Business of Venture Capital: Insights from Leading Practitioners on the Art of Raising a Fund, Deal Structuring, Value Creation, and Exit Strategies, 2nd Edition

CHAPTER 5 How Limited Partners Conduct Fund Due Diligence

“If it takes $10 million to make a good VC, that $10 million better come from the LP next door.”

—Anonymous LP

Fund due diligence begins and ends with the team—the general partners (GPs). If the investment team has a strong performance track record and relevant expertise, and is pursuing a compelling strategy, fund raising can be a lark.

The due diligence process at the fund level is similar to that of due diligence in start-ups: source a few thousand opportunities, invest in a handful, and get returns from a few.

Limited partners (LPs) proactively seek prudent and experienced fund managers who can be good stewards of their capital and generate strong returns. But no LP hangs a sign at the door; rather, the communication channels are informal. Seasoned professionals, those top-quartile managers with demonstrated track records over multiple fund cycles, are sought after. Yet, others focus on the other end of the spectrum: emerging managers, who may bring a fresher approach, energy, and malleability to the mix. All fund-raising is at the mercy of markets—with Mr. Market on its side, even a mediocre group may have an oversubscribed fund.

A typical investment process for any LP seeking to invest in venture funds follows the following steps:

• Sourcing and screening of fund managers: The art of finding the right fund managers.
• Fund due diligence: The ability to assess the various risk-return measures for investing in such ...