Should I Take This Money? 5 Major Ways VCs Invest In You — And How To Think About It

VCs come in many different shapes: investment thesis, fund size, geographic focus, profit-motivated versus strategic returns, and how they invest. Indeed, VCs use a variety of investment vehicles including opportunity fund, special-purpose vehicle (SPV, also often called sidecar fund), cross-fund, evergreen fund, and scout fund. But what is the impact for startups? This post will focus deeper on this topic from an entrepreneur’s perspective, using the same 5-point framework.

1) Opportunity Fund — An opportunity fund is essentially extra money with different goals than the main fund. The two main goals are typically to (i) double-down on existing investments and (ii) make opportunistic investments in a new geography, sector, or stage. A firm can have many different opportunity funds at any given time, with different LP bases, and with different splits between these two goals. Entrepreneurs may not be aware of any of this complexity and in fact, it rarely impacts their business meaningfully. The key is to know how much attention the VC pays to their opportunity fund versus their main fund. The investors’ time commitment and follow-on strategy (i.e., whether they will continue investing in future rounds) are the two most important questions. After all, entrepreneurs should be optimizing for those investors that will help them beat the odds, which is especially the case if a VC is taking a significant position. If you get satisfactory answers then there is no reason to think of an opportunity fund differently than the main fund.

2) Special Purpose Vehicle (SPV) — A SPV is a vehicle created specifically to make their investment, often because the VC wants to increase the pool of capital and / or bring in other investors into the deal. Scenario #1, which happens more commonly in small funds, is the GPs bring in LPs into the deal, ie the investor is bringing in their own investors. Scenario #2, which happens more commonly in large funds, is the GPs are putting in their personal capital into the deal. Remember that GP is General Partner i.e., someone actually running the fund and LP is Limited Partner i.e., someone invested in the fund as a passive investor.

How should you think about scenario #1, namely taking your investors’ investors? It depends much on expectations. If you are building a cybersecurity company and your VC brings into the deal a LP who is a CISO, it could be a huge boon. But if the LPs will require more management that you are not ready for, then it may not be adding as much value. How should you think about scenario #2, namely mixing professional and personal investment? It can be a sign of even higher conviction and commitment from the VC, which helps especially in raising more capital. But most firms also have guidelines on such sidecar investments since the GP may act in his / her personal best interest instead of the firm’s.

3) Cross-Fund — Cross-fund investments are less common in the industry because they typically have different LPs. Also, the complexity here should matter very little to an entrepreneur since it’s ultimately just different main funds from the same firm. Where it could have an impact is if the different main funds have different follow-on strategies, which could be correlated to their performance. For instance, say a fund II with 50% reserves and a fund III with 10% reserves are both investing in you. Should you expect a lower level of commitment in the future because of this difference in follow-on capital? Understanding the VCs’ commitment for the future is always an important question, in this case it becomes even more so.

4) Evergreen Fund — These are funds that have the ability to draw capital indefinitely, which is obviously a plus for startups. “Indefinitely” here refers to within the 10 years or so time frame of a startup. The one caveat to keep in mind is that evergreen funds don’t have to worry as much about fundraising so the GPs have more time but also less pressure on them — it boils down to the firm’s culture and each personality on how that plays out.

5) Scout Fund — Scout fund is about a large fund giving a small blank checkbook to someone else to write checks on their behalf. Big yellow flag for entrepreneurs — you can run into signaling risk. Say a scout for a $1B fund put in $100K into your seed, the expectation is that fund should lead your A and if they don’t the market will ask why. That said, scout funds can be incredibly powerful for exactly that reason i.e., if you perform well your future fundraising could be even easier. The scout and the parent fund are unlikely to be active investors but you can also leverage their brand especially for hiring, BD and PR. Finally, one common mitigant to this signaling risk is to have at least two if not multiple scout funds invest in you, which increases your optionality.

Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.