Monday, December 23, 2024

A new approach for venture capitalists to find the right LPs

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Dmitri Smirnov

In the third quarter of this year, venture capital funding contracted significantly, with just $66.5 billion raised, a 16% drop from the previous quarter and 15% year over year. In this challenging environment, institutional investors are becoming more cautious and reevaluating their investment strategies. For some VCs, this highlighted an often overlooked fundraising approach: recruiting entrepreneurs, including former portfolio founders, as limited partners.

This is why it worked for us.

Why choose founders as LPs?

Dmitry Smirnov, Founder and Partner of Flint Capital

Institutional investors can be a reliable source of funding, but they come with long onboarding cycles and high reporting requirements. Conversely, technology-driven, entrepreneurial LPs make investment decisions quickly and offer flexibility in check size. Many of our LPs are able to make strategic adjustments throughout a fund’s lifecycle by starting as small as $1 million to $2 million and increasing their commitment as they see results. .

Some of the entrepreneurs we have as LPs are actually founders of previous portfolio companies, such as CyberX (acquired by Microsoft in 2020). Inviting them as LPs creates a natural, trusting partnership rooted in shared experience and mission. This loyalty and commitment is unique to the founder-LP dynamic.

How to build and maintain these partnerships

At Flint Capital, we’ve always positioned ourselves as a “founder-friendly fund,” and we’ve been very intentional about that. When we see something unfair happening, we step in as arbitrators to resolve it.

For example: A significant strategic investor is looking to get into one of our portfolio companies and we have agreed to a valuation. But then they came to us and offered us a premium above the set valuation. So while that means we’re making more money on our stock, they’re trying to significantly reduce the founder’s valuation compared to what we’ve been talking about.

They told us, “Do not disturb,” and we were forceful, “No, that’s not going to happen.” We have established a consolidated position for sale and have agreed on a valuation, and either the transaction will occur at this valuation or it will not occur. The investor went ahead and completed the transaction based on the terms originally agreed to.

Besides business discussions, we also spend time together. We play paddle tennis, drink alcohol, go to Vipassana meditation retreats, and run races. Sometimes I go hiking or party at Burning Man.

I have countless stories, but they all convey the same message. When our founders realize we support them, they feel the power of true partnership.

Building a collaborative culture

Entrepreneurial LPs bring not only capital, but also networks, insights, and credibility.

To make the most of these benefits, it is very important to maintain open communication channels and update regularly on developments. Not only will they value this, they can add more support by contributing to your pipeline and referring leads to whatever your needs may be. Direct, results-oriented conversations like this resonate more than extensive reports and procedures.

This creates a virtual advisory board that is critical to identifying trends and adapting strategies. Entrepreneurs-turned-LPs bring deep industry expertise and easily connect with current founders to help them overcome the challenges of scaling. This relationship of trust is difficult to replicate with institutional investors alone.

A model that is not for everyone

Raising money from entrepreneurs may not be the right choice for every fund. Institutional LPs remain the bedrock for many VCs, providing stability and large amounts of capital that many companies rely on. However, if you are looking for a more agile, relationship-driven approach, building an LP base with founders may be a practical and strategic alternative.

With over 15 years of experience in venture capital investing, Dmitry Smirnov is the founder and partner of Flint Capital, a Boston-based VC fund that invests in early-stage technology companies in the United States, Europe, and Israel. The company has had 22 successful exits, 2 IPOs, and 3 unicorns.

Illustration: Dom Guzman

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