Venture Deals, 4th Edition

CHAPTER 12How Venture Capital Funds Work

At this point, you should be familiar with different types of financings, the terms, and have some ideas on how to best maximize your chances to get a term sheet or three. In the next chapter we’ll explore different negotiating strategies. But, before we do that, it’s useful to understand the motivation of the person you’ll be negotiating against, namely, the 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 that 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 investors since 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 the illustration ...