Business plan, check. Early traction, check. Happy customers, check. Financial model, check. Pitch deck, check. Investment, not so fast. Is your startup checking all the boxes but still not receiving any interest from investors? Well it might not be your business that is preventing you from raising capital. It could very well be the AMOUNT of money you are asking for. The venture capital (VC) landscape is set up with a high concentration of smaller investments ($500K-$1M initial check) and a high concentration of larger investments ($10M-$20M initial check) and not a whole lot in-between. This gap is a concept I like to call, the VC dumbbell. Let's explore exactly why this gap is formed and how it can affect your ability to raise capital.
Creating the Dumbbell Heads: Exploring Limited Partners
To understand the VC dumbbell, we first need to understand how VCs are formed. A typical VC will have Limited Partners (LPs) who give their money to a few General Partners (GPs) who are in charge of investing it in companies and managing those companies in order to get a return. There are a few different types of LPs. The smallest and most common are high net-worth (HNW) individuals. However, there are also larger sources of capital like family offices, pension funds, endowments, and sovereign wealth funds. In most cases, the number of LPs allowed in a fund is capped at 99 and there is typically a minimum investment amount all LPs need to commit.
A fund that is composed of mostly HNW individuals might have minimum investment commitments of $300K to $500K. This gives these funds a size of about $30M - $50M. These funds form the first head of the dumbbell. On the other hand, you have the funds whose LPs are primarily institutional investors, let's say endowments. These are typically large buckets of money so the endowment itself might have a rule that it's smallest check size is $10M. They might further restrict their investment with a rule that they can't be more than 10% of the total amount of money committed in any fund. If you just did some quick math, that makes the minimum size of the fund $100M which automatically excludes them from the HNW individual funds outlined above. This is how the second head of the dumbbell is formed. Large institutional investors end up joining together to make massive funds. If you take the $10M minimum for the maximum number of LPs, you end up with a fund of about $1B.
The below illustration summarizes the characteristics of the dumbbell:
The Headache of Raising Capital on the Handle
Now that you know how the VC dumbbell is formed, hopefully you understand the problems it can cause. Let's first look at the HNW LP fund. You won't typically see a larger initial check here, since it limits the funds' ability to invest in other companies or hold back dry powder to double down on the winners. Like I stated above, the initial check size of these funds is typically pretty small ($500K - $1M). So, if you are looking to raise $5M then you might need to get commitments from 5-10 of these smaller players. It is difficult to raise money from ONE investor much less 10.
Now let's look at the larger funds. They can easily write an $8M dollar check. So if I need more money then I can just go to them right? Well it's not that simple. The issue with the larger funds is they need a big return. A $25M dollar exit on the $50M HNW LP fund above is great, it returns 50% of the total fund value. However, the same $25M dollar exit on our $1B institutional LP fund returns only 2.5% of the fund value. That is not enough to move the needle, so this type of fund will not write a $5M check with the hope of a $25M return. Unless you have huge upside and potential for a big exit, you will likely be closed out of access to these types of funds.
So where is that amazing $275M fund that writes the $5M check you so desperately need? The truth is those types of funds can be rare, they are on the "handle" or thin part of the dumbbell. You might get a fund of ultra high net worth individuals, small institutional investors like family offices, or some blend, but you really have to dig to find them. Raising capital on the handle is hard, but it's typically the first place founders like to go. "I need $5M, $8M, $12M" and that could definitely create some headaches.
Summary - Do More With Less
The very construction of VC firms creates a dumbbell type shape with lots of small funds, lots of big funds, and only a small amount of middle size players. Most businesses will get shutout from the larger funds so you should focus on the smaller ones. Do more with less. Instead of $5M or $8M what could you do with $1M or $2M? That's still A LOT of money and VC's will be much more willing to pull the trigger on a deal like that. Try to focus your business and do more with less money. You will have a lot more success in both your business and your capital raise.
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