Venture Capital: so you want to invest in startups, anon?
Happy Monday, friends!
How do you become a VC? How do you create a VC?
How do you become a successful VC?
And what does it take to have an opportunity to invest in protocols and be at the forefront of the markets?
This is what I am trying to answer today.
Venture Capital: so you want to invest in startups, anon?
Introduction
One day, you look at the markets and understand that you are not satisfied with the current rewards you receive. Markets are going down, and your investments are suffering.
Another day, you look at the markets and see how everyone profits, but you’re still underperforming as an individual compared to big teams. But who are these big teams?
There are multiple entities such as Market Makers, Hedge Funds, Liquid Funds, and Venture Capital Funds (VCs). The first three entities operate somewhat similarly: they buy and sell tokens already on the market. However, VCs are the ones who buy tokens even before they’re live on the markets.
VCs support the teams behind your favorite projects from the beginning, even while the team is still developing the MVP (minimum viable product). These are the people who strongly believe that a particular team will succeed, and they’re ready to contribute a lot of money even before the product is live.
Their investment can grow significantly if the project is successful, but they can also experience significant losses if the project fails.
The risk/reward ratio here is high, but Venture Capital is not just about investing; it’s about supporting the teams and working with them directly to ensure the project’s long-term success.
So, how do you become a VC? How do you create a VC? How do you become a successful VC? And what does it take to have an opportunity to invest in protocols and be at the forefront of the markets?
To create a VC, you have to understand the fundamental VC structure, and most importantly, the main figures of this structure
There are 3 main parties that each VC fund has: Limited Partners (LPs), General Partners (GPs), and Founders:
LPs are people with lots of money looking to multiply their capital; one of the options they have is through venture investments.
GPs are people with lots of knowledge looking to multiply LPs’ investments and earn a fee from successful deals.
Founders are the people who build an innovative single product or service and aim to bring it to the market. They need investments to get started.
If I had to describe the VC structure in one picture, I would probably use this picture:
LPs' delegation to GPs is pretty clear; they just delegate the money and wait for the returns. LPs' main task here is investing in the right people who will manage the money. The goal for LPs is to aim for the significant.
LPs are normally not involved in the process of investing in startups, as all of the due diligence is handled by GPs. However, LPs can bring deals from their network for GPs’ review and opinion on whether it’s worth investing or not.
GPs usually conduct reports every month/quarter/year to let LPs know the current situation of a VC Fund. That involves providing any changes in the investing strategy, market sentiment, overall completed investments, and unrealized (or realized) returns.
The goal for GPs here is to be as transparent as possible because everyone understands that VC is a risky business; only 1 out of 100 startups becomes a unicorn (a company that reaches a valuation of 1 billion dollars).
The typical VC fund operates within a model called 2/20. That means that GPs charge 2% per year of the total LP capital invested for operation purposes (mainly salaries, partnerships, agreements, legal, etc.).
Moreover, GPs charge a 20% fee for every successful investment they’ve made, which is also called “carry.” That means if the total ROI (return on investment) is equal to 1 million dollars, 800k goes to LPs, and 200k goes to GPs as a success fee for their work.
It’s important to mention that most VCs are not good, and they don’t bring that many returns. But why do LPs keep investing in them?
The VC business means mostly illiquid assets which are not correlated with other assets, so that kind of hedges the risks with a small part of their total AUM (assets under management). Big institutions and high-net-worth individuals usually allocate 5-10%.
However, the right GP can bring significant returns. In 3-5 years, LPs can receive 3-10x, which is usually impossible in other asset classes.
But how to stand out so LPs choose you instead of another Fund Manager?
Pitching is an art, and art becomes better with every iteration
Yes, you wanted to invest in other startups, but at the beginning, you also have to fundraise; otherwise, what are you going to invest?
Raising for your fund is a unique process because you can understand what it’s like to pitch to other people, because in the end, there are going to be other people pitching to you.
The process is almost no different from traditional fundraising. However, there are some differences. First of all, if you’re a crypto-native fund, you will invest only in crypto companies (otherwise, what’s the point of the fund).
But LPs can be very diverse people. If you are raising for a crypto fund, it does not necessarily mean you have to find LPs who are also crypto-native.
What you have to do is prove that you’re capable of performing and bringing significant returns to them. For example, I have a friend who is a GP at a crypto fund, and his LPs include people from e-commerce, real estate, oil production, etc.
The plan is called a “Fund Thesis.” That’s actually just a bunch of parameters you optimize to make your investments more focused and productive.
Some of the parameters include:
Investment Stage. There are 6 of them: Pre-seed, Seed, Series A, Series B, Series C, Series D. Also, sometimes startups raise “private rounds,” which is basically a fancy way of hiding what stage you’re at. Focus on Pre-seed, Seed, and Private rounds; they bring the best returns but also introduce higher risks. It will definitely prove whether you’re successful or not.
Value Add. That’s possibly the most important parameter. Most of the time, investors would prefer smart money rather than “invest and forget.” So you have to bring something to the table. For example, a16z offers literally everything. They will help you with research, marketing, product development, hiring, and many more things. Identify what you (and your team) can bring besides money, and focus on it.
Not surprisingly, most VCs don’t provide any value besides money, and that’s usually how you can distinguish great VCs from normal VCs. That is particularly seen in bear and bull markets.
In a bull market, there are a lot of projects and a lot of capital. Everyone is going crazy (retail especially), and even the shittiest token can get you 10x or so. VC Funds have to fight for allocation even for bad projects because the demand for tokens is pretty high. That creates situations where you can’t properly manage the risk/reward ratio because everything will grow anyway.
However, in a bear market, there are a lot of builders (because a bear market is great for building, such a peaceful space) and not a lot of capital because barely anything grows.
That is the time when great VCs are defined because you truly have to rely on a lot of metrics, the team behind the project, a sustainable token model, technical solutions, and overall vision and go-to-market strategy. That involves much more skill, experience, and even intuition sometimes!
So if you’re starting a VC from scratch, it could be better to do it in a bear market or at the end of the bull market, so you have less competition and more options to choose from.
People Matter - who should you hire?
Yes, the team matters the most, like everywhere. Human capital is the most important capital, so how do you hire a great team and who should you actually hire? The answer to this question is simple and somewhat “cliché,” but — hire people who are smarter than you to form a team that will outplay the market.
In most cases, the VC team is actually small; you don’t need more than 10 people to manage $50M or even more. Because the process is actually simple: find (or be found by) startups → identify the best ones → invest → help the startups grow → sell your share (tokens) → get the returns.
But in reality, it requires lots of experience and knowledge to perform each task in the best way. You obviously can’t do this alone, so your dream team looks something like this:
Associates are responsible for almost all communications between the VC Fund and startups. These individuals usually do the initial screening of startups and provide feedback. They communicate before the investment, during the investment, and after the investment.
They also scout projects from any possible source: Twitter, alpha groups, local meetups, conferences, demo days, hackathons, etc. Associates also establish deal flow partnerships between different VC funds, where entities share the deals they’re receiving from their network. That drives collaboration between the funds.
Researchers usually do everything related to research: tokenomics, business model, technical solutions, market, etc.
Researchers are also usually responsible for looking at the bigger picture and predicting trends and narratives. For example, you might research a project that can potentially become your portfolio company.
And it’s good, but for example, you can predict what the market will look like in 6-12 months, and what companies can drive the value there. So it gives you a better perspective to look at the overall market situation, rather than a particular protocol.
Advisors provide specialized expertise and strategic guidance to both the VC firm and its portfolio companies. They often act as part-time consultants.
Their roles include sourcing potential investments, conducting due diligence, and offering strategic advice to portfolio companies. Advisors share networks to connect startups with key resources and potential partners.
IR (Investor Relations) specialists at VC Funds usually attract and maintain investor relationships. They work closely with the firm's partners to develop and execute fundraising strategies, create investor materials, manage communications, and other tasks. They often handle media inquiries, prepare for investor meetings, and track investor sentiment.
Each component of a team is important, and the key task for the GP is to ensure the team works in unison and delivers (apart from overseeing fund strategy and overall performance).
Organizing Dealflow & Strategy
Investing is tough, so we just go with the flow? Well, it could’ve been like that… But, it would be too easy to just go with the flow. It’s better to form a legacy for better performance, so you progress over time.
What do I have to do to properly grow over time?
Put each startup in a legacy table. Form a list of competitors over time, their performance, and valuations. A quick summary of each project will help a lot in the future when you have a database of 300+ startups to extract as many insights as possible.
Work with associates more and explore the best strategies to hunt the project. When you’re famous enough, you usually don’t have to do anything — startups will just discover you on their own. However, when you’re growing, you have to be literally everywhere. Snipe hackathons, demo days, early-stage groups, etc.
Not only snipe, but be flexible. If you see a startup that’s not worth your attention and you can spot it from the first conversation, don’t spend your valuable time. If you see that a startup is too good and you understand that they will close the round soon — be as flexible as possible to get the best deals.
Increase your presence online. For the online, publish articles especially focused on topics your fund is interested in. For example, Paradigm was researching MEV a lot, and they ended up investing in Flashbots (R&D organization formed to mitigate the negative externalities posed by MEV).
What To Look for When Investing?
There are countless metrics you can rely on while investing or choosing the right project for investing, but when you have a protocol on your table and the only question is whether to invest or not, there are possibly a couple of parameters you should look for.
Tokenomics. Study inflation rates, emissions, payments to stakers, if that’s the case. The main point is to avoid selling pressure and see some strong mechanics of the token to motivate people to keep buying it.
Tech / Fundamentals. That’s possibly the most difficult topic to study. If you have a highly complex project — you should have someone with expertise to outline what you should look for. Analyzing NFT collections is easy, but understanding the mechanics of a separate L1 blockchain, or SDK for developers is way harder.
Competitors. Look for competitors of the protocol you potentially want to invest in. How do they perform? What market share do they own? How are they different? Are they better or worse? In which way? In comparison, you can learn more about the project you’re researching.
Ecosystem. Usually, most of the protocols base in only 1 ecosystem: either Ethereum, Solana, some Layer 2, Cosmos, etc. The goal here is to see whether the particular protocol fits in the ecosystem. For example, someone might build some farming protocol on Optimism. But there is no reason for it, as Optimism is not focused on DeFi. You have to look for such moments to ensure the protocol will find its PMF (product market fit).
Investors’ Research. If a project is raising their 2nd or 3rd round, they have already had backers before. You can study the backers, they’re usually divided by tiers, the smaller the tier — the better. For example, Multicoin is considered tier 1 and it is one of the best VCs in crypto, while Outlier Ventures is approximately tier 4. You can check some of the funds in this table.
Team. Ensure that all of the team members have relevant experience and vision to build a successful project. Do they know what they’re talking about? Are they smart? Do they fully understand the proposition? If you were in the same team as they are, would you be comfortable?
There are more parameters such as sentimental analysis, on-chain analysis, analysis of the partners, differences between pre-market and secondary market. The tip here is to try the investment look bad unless proven otherwise.
So find the parameters and indicators that prove that this could be a good investment. If you don’t find any, it really could be a bad investment.
Conclusion
Starting your own VC fund could be a pain at the beginning, because setting up operations and processes is always stressful. If you moved out from one city to another one, you understand what I am talking about. But it eventually gets better.
The goal here is to return the fund, for example, if the total capital you have to invest is 100M and your average check is 1M for 10% of the protocol, then it takes exactly one unicorn so your share is worth 100M, so you can return the fund to the investors.
Remember, investing is art, pitching is art, communication is art, and researching is art. Practice until you and your fund become one of the most recognizable artists.
That was it for today.
See you around, anon.
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Masterpiece !
Thank for sharing ser 🙏