Venture Capital & Term Sheets
How venture funds raise money, pick deals, get paid and exit, so founders can understand what drives an investor's yes or no.
The big idea
Written mainly for people entering the venture industry, the book explains a VC firm as a business in its own right: it raises money from limited partners, operates on a roughly ten-year fund life, earns fees and a share of profits, and must return capital to its own investors. Seen from the founder's side, many investor decisions that look personal are really driven by fund size, fund age, reserves and the firm's own fundraising needs. Understanding that machinery helps you target the right investors and read their signals.
Key takeaways
Venture funds raise money from limited partners such as pension funds, endowments, foundations and family offices, and commit to a strategy covering stage, sector, geography and check size. A partner who strays from that strategy makes the next fund harder to raise. 'Outside our thesis' is often a constraint, not a judgment of your company.
Venture returns are dominated by a few big winners, so investors ask whether a company could, by itself, return the entire fund. A company that will reliably become a solid mid-sized business can be a great business and still a poor venture investment. If your realistic ceiling is well below that bar, other capital such as revenue-based financing or strategic investment may fit better.
Funds typically invest in new companies during their first few years, then shift to follow-on investments in existing portfolio companies, then focus on exits. A partner late in a fund's life may have little capital left for new deals. Ask which fund they are investing from and how much of it is still available for new companies.
Many funds set aside a large share of capital, often around half, for follow-on investments in existing companies. A fund that has reserved meaningful follow-on capital for you is more likely to support you in a difficult later round than one that wrote a bigger first check but has nothing behind it.
Managers typically earn an annual management fee of around 2% and carried interest of around 20% of profits, and carry usually pays only after limited partners get their capital back, sometimes plus a preferred return. That structure explains why investors often prefer to swing for a large outcome rather than accept a modest early acquisition.
Investors see far more companies than they can study deeply, so they rely on heuristics, warm introductions and backchannel references. Identify the risks they are likely to worry about, bring evidence that reduces each one, and make sure the customers and colleagues they may call can speak specifically about you.
Firms raise new funds every few years and are judged by their limited partners on returns, distributions and portfolio quality. Where a firm is in its own fundraising cycle can affect its appetite for your round, its pace, and the kind of companies it wants to show.
The framework
Pensions, endowments, foundations and family offices commit to a fund with a defined strategy.
Early years go to new companies, with reserves held for follow-ons.
Middle years focus on follow-on rounds and helping winners grow.
Acquisitions and IPOs return capital, LPs first.
Managers share profits only after LPs are repaid, then raise the next fund.
Apply it this week
Read next
An investor's-eye view of how venture funds work, so you can read a term sheet and pick partners with open eyes.
A history of venture capital that explains why investors behave as they do, through the one statistical rule that drives their returns.
The textbook math behind how venture capitalists value startups, size ownership, and structure preferred stock.
This page is an original summary and commentary prepared by XRAYCLOUD.AI with AI assistance. It is not affiliated with or endorsed by the author or publisher, and it is no substitute for the book — read it for the full argument.