Airstream Alpha provides Modern CFO & Back Office Solutions to entrepreneurs & investment firms, specifically venture capital, private equity and hedge funds, as well as bespoke investment vehicles.

Our team has extensive experience working with and investing >$1 billion in >100 investment firms and companies (thousands evaluated).

Learn more about what we do, tell us about yourself and how we can help at www.airstreamalpha.com.

TLDR

• Fund Launch Series Part 1 of 3: Define Your Unique Investment Strategy & Build Your Fund Model!
• As a fund manager, your key priorities are to source / invest in great companies (investment strategy) and raise the capital to do so. You need a sound investment strategy (backed up by your fund model) to do both 
• Best practice is to clearly define your investment strategy & build your fund model before talking to potential investors

At Airstream Alpha, we’ve spent years working with funds as LP investors and CFOs, giving us a unique perspective. Recently, when we’ve asked new and prospective fund managers what problems and frustrations they face, we’ve been hearing a response more and more frequently: it’s hard to find a clear, concise guide that covers “fund launch” while also providing relevant tools and tactics fund managers can use! 

We’ve written this “Fund Launch” series as a result! Part 2 (Show Me the Money! Fundraising & De-mystifying LPs) and Part 3 (CFO Foundations: Build Your Budget) are next. We’ve also shared our Modern CFO & Back Office Strategy Guide as a cheat sheet for you to think through these dynamics and all the rest!

Know Your Audience Part 1 (More to Come in Part 2)

The CFO work we’ve been doing with existing and prospective fund managers around Fund Launch has pushed us to reflect on our experience as full-time LPs (and consult with a few of our old LP friends). We encourage fund managers to do the same – try to put yourself in the LP’s shoes! 

LPs, especially institutions, are constantly assessing the feasibility of a fund’s thesis or investment strategy and the mathematical soundness of their fund model and portfolio construction. Strategy & fund models matter!

As a LP, let’s say I had an existing portfolio of 10 venture managers and was constantly meeting with others, trying to establish who we should add to our portfolio. In every meeting, I was trying to understand a manager’s investing strategy – how do they A) access and invest in the best companies and B) ensure their fund is appropriately constructed with the right amount in each of those investments to maximize returns? Also, C) how are they unique?

More simply put, what is their investment strategy?

Define Your Unique Investment Strategy

Most LPs and GPs have read up on investment strategy from the likes of Chris Dixon @ a16z, Brad Feld @ Foundry, Fred Wilson @ USV and Mark Suster @ Upfront (if you haven’t, it’s worth it). These investors and their firms clearly define their investment strategy and share specific tactics and tools behind them. What are yours? First, put thoughts down on paper, and then work to bring them to life as you craft your fundraise deck.

Once it’s down on paper and in your fundraise deck, it’s important to also bring it to life by clearly articulating this in your conversations with prospective LPs, other GPs, and entrepreneurs. How are you unique? How will you add value? Are you a person that each of these constituents want to do business with?

Having thoughtful, clear and concise answers to these questions are crucial! Remember, you’re playing the long game – people talk, and you never know who will receive a phone call as a reference before a LP invests (I completed more than 1,000 reference calls as a LP)!

Why Build Your Fund Model? A Story…

Building a fund model can seem overwhelming at first, but don’t worry there are tools out there to make it easier! It’s also a constructive exercise as it will force you to think through the details of portfolio construction, including fund size, number of initial investments, follow-on and reserve ratios, management fees, recycling, and how all this drives returns!

A real-world benefit I’ve seen as a LP and CFO is that it will help you reduce temptation. 

Example: let’s say you’ve just completed your $15m first close on your way to a $30m target. You’re feeling great and expect the final close on $30m in three months! Guess what? Things happen (see 2020), investor priorities change, and this target isn’t guaranteed! 

Now, you’ve just received a $3m allocation in a hot Series A round you’ve been tracking. Is $3m the appropriate size given your fund model and constraints? Your fund size right now is $15m, not $30m. Your fund model isn’t emotional and will not lie – it will tell you no, $3m is too much (for traditional VC strategies)!

Building Your Fund Model & Portfolio Construction

Similar to investment strategy, portfolio construction and fund models have been written about and shared online. Hadley Harris & Kristin McDonald @ Eniac Ventures did a great job addressing several key issues in their 2020 post. Fred Wilson @ USV has also addressed crucially important details such as recycling.

Your initial strategy is just a starting point and must be measured and adjusted over the life of the fund. Also, getting recycling right is challenging, so make sure to use a holistic model that pulls in everything to optimize your chances.

Ultimately, most sophisticated institutional LPs will ask to see a fund model before making an investment. It’s important to spend the time to build your own based on your best guess of what the future looks like today.

Final Thoughts

We believe that defining your unique investment strategy and building your fund model go hand in hand. Fund managers that go through this process will be better positioned to maximize returns for LPs and themselves by sourcing and investing in the best companies. They’ll also be more likely to appropriately size these investments, driving outperformance and successful growth of their fund franchise!

We hope that this article and attached fund model will be helpful to fund managers so that they can spend more time focusing on sourcing great deals, working with entrepreneurs, and communicating with LPs!

Stay tuned for Part 2 (Show Me the Money! Fundraising & De-mystifying LPs) and Part 3 (CFO Foundations: Build Your Budget). We appreciate you reading and sharing with your network!

Special thanks to David Perretz for his significant contributions to this article.