Venture Deals, 3rd Edition

CHAPTER 10 How Venture Capital Funds Work

Before we talk about the dynamics of negotiating the deal, it’s useful to understand the motivation of the person you’ll be negotiating against, namely, the venture capitalist (VC). We’ve been asked many times to divulge the deep, dark secrets of what makes VCs tick. One night over dinner we talked through much of this with a very experienced entrepreneur who was in the middle of a negotiation for a late stage round for his company. At the end of the discussion, he implored us to put pen to paper since even though he was extremely experienced and had been involved in several VC-backed companies, our conversation helped him understand the nuances of what he was dealing with, which, until our explanation, had been confusing him.

In general, it’s important to understand what drives your current and future business partners—namely, your VCs—as their motivations will impact your business. While the basics of how a venture fund works may be known, in this chapter we try to also cover all the nonobvious issues that play into how VCs think and behave. To do that, we’ll dive into how funds are set up and managed as well as the pressures (both internally and externally) that VCs face.

Overview of a Typical Structure

Let’s start by describing a typical VC fund structure (see illustration). There are three basic entities that make up the fund. The first entity is the management company and is usually owned by the senior partners. The management ...