Author: Route 2 FI; Translated by: Deng Tong, Golden Finance
How do you become a venture capitalist? How do you create a venture capitalist?
How do you become a successful venture capitalist?
How can you get the opportunity to invest in protocols and be at the forefront of the market?
That’s the question I’m trying to answer today.
Preface
One day, you look at the market and realize that you are not satisfied with the returns you have received so far. The market is going down and your investments are suffering.
Another day, you look at the market and see that everyone is making profits, but you are still underperforming individually compared to the big teams. But who are these big teams?
There are multiple entities such as market makers, hedge funds, liquidity funds, and venture capital funds (VC). The first three entities operate in a somewhat similar way: they buy and sell tokens that are already on the market. However, VCs are the ones who buy tokens before they go live.
Venture Capital firms support the teams behind your favorite projects from the beginning, even when the teams are still developing MVPs (minimum viable products). These people are so convinced that a team will succeed that they are ready to invest a lot of money even before the product is launched.
If the project is successful, their investment can grow significantly, but if the project fails, they can also suffer significant losses.
The risk/reward ratio here is high, but venture capital is more than just investing; it’s also about backing the team and working directly with them to ensure the long-term success of the project.
So how do you become a venture capitalist? How do you create a venture capitalist? How do you become a successful venture capitalist? How do you get the opportunity to invest in protocols and be ahead of the market?
To create a VC, you must understand the basic VC structure and, most importantly, the key players in that structure.
Every venture capital fund has three main parties: Limited Partners (LPs), General Partners (GPs), and Founders:
LPs are people who have a lot of money and want to increase their capital; one of the options they have is through venture capital.
GPs are people with a lot of knowledge who want to grow the investments of their LPs and earn fees from successful deals.
Founders are people who create an innovative single product or service and aim to bring it to market. They need investment to get started.
If I were to use a picture to describe the VC structure, I would probably use this picture:
LPs’ mandate to GPs is very clear; they just entrust funds and wait for returns. LPs’ main task is to invest in the right people to manage the funds. LPs’ goal is to target major targets.
LPs are not usually involved in the process of investing in startups, as all due diligence is handled by GPs. However, LPs can bring deals from their network for GPs to review and determine if they are worth investing in.
GPs typically report monthly/quarterly/annually to keep LPs informed of the current state of the VC fund. This includes providing information on investment strategy, market sentiment, overall completed investments, and any changes in unrealized (or realized) returns.
GPs aim to be as transparent as possible because everyone understands that VC is a risky business; only 1 in 100 startups will become a unicorn (a company valued at $1 billion).
Typical venture capital funds operate on a model called 2/20. This means that the GP takes 2% of the LPs’ total investment each year for operational purposes (primarily salaries, partnerships, agreements, legal, etc.).
Additionally, GPs receive a 20% fee for each successful investment they make, also known as a “carry.” This means that if the total return on investment (ROI) equals $1 million, the LP will receive $800,000 and the GP will receive $200,000 as a success fee for their work.
It’s worth mentioning that most VCs aren’t very good and they don’t bring that much return. But why do LPs continue to invest in them?
The venture capital business mainly deals with illiquid assets that are not correlated with other assets, so this can be hedged with a small portion of its total AUM (assets under management). Large institutions and high net worth individuals usually allocate 5-10%.
However, the right GP can bring considerable returns. In 3-5 years, LPs can get 3-10 times the return, which is usually impossible in other asset classes.
But how do you stand out and make LP choose you instead of other fund managers?
Sales pitching is an art, and it gets better with every iteration.
Yes, you want to invest in other startups, but you also have to raise money at the beginning; otherwise, what are you going to invest in?
Raising money for your fund is a unique process because you can understand what it’s like to pitch to other people because, ultimately, someone else will be pitching to you.
The process is pretty much the same as traditional fundraising. However, there are a few differences. First, if you are a crypto-native fund, you will only invest in crypto companies (otherwise, what’s the point of a fund).
But LPs can be very diverse people. If you are raising money for a crypto fund, it doesn’t necessarily mean you have to find LPs that are also crypto-native.
What you have to do is prove that you have the ability to bring them a good return. For example, I have a friend who is a GP of a crypto fund, and his LPs include people from e-commerce, real estate, oil production and other fields.
The plan is called a "fund thesis." It's really just some optimized parameters that make your investments more targeted and efficient.
Some of these parameters include:
Investment Stage. There are 6 investment stages: Pre-Seed, Seed, Series A, Series B, Series C, Series D. Also, sometimes startups will do a "private placement," which is basically a fancy way of hiding what stage you are at. Focus on Pre-Seed, Seed, and Private Placements; they bring the best returns, but also carry higher risk. It will definitely tell whether you are successful or not.
Added value. This is probably the most important parameter. Most of the time, investors prefer smart money over "invest and forget". So you have to bring something to the table. For example, a16z offers almost everything. They will help you with research, marketing, product development, recruiting, etc. Determine what you (and your team) can bring to the table besides money, and focus on that.
Not surprisingly, most VCs offer no value other than money, which is often what separates the good VCs from the average ones. This is especially true in bear and bull markets.
In a bull market, there are a lot of projects and a lot of capital. Everyone is going crazy (especially retail investors) and even the worst tokens can get you around 10x. VC funds have to fight for allocations to bad projects because the demand for tokens is so high. This creates a situation where you can't properly manage the risk/reward ratio because everything will grow anyway.
However, in a bear market, there are a lot of builders (because bear markets are great for building, it’s such a peaceful space), but not a lot of capital because almost nothing will grow.
That’s when a good VC firm is defined, because you really have to rely on a lot of metrics, the team behind the project, a sustainable token model, the technical solution, and the overall vision and go-to-market strategy. This sometimes requires more skills, experience, and even intuition!
Therefore, if you are starting a business from scratch, it is best to do it during a bear market or at the end of a bull market so that you will have less competition and more choices.
People Matter – Who Should You Hire?
Yes, the team is everything, just like anywhere. Human capital is the most important capital, so how do you hire a great team and who exactly should you hire? The answer to this question is simple and a bit "cliche", but - hire people smarter than you to build a team that can outperform the market.
In most cases, venture capital teams are actually small; you don’t need more than 10 people to manage $50 million or more. Because the process is actually very simple: find (or be found) startups → identify the best startups → invest → help the startups grow → sell your shares (tokens) → get returns.
But in reality, it takes a lot of experience and knowledge to perform each task in the best possible way. You obviously can’t do it alone, so your dream team looks like this:
Partners are responsible for almost all communication between VC funds and startups. These individuals typically do the initial screening of startups and provide feedback. They communicate before, during, and after an investment.
They also scout projects from any possible source: Twitter, alpha groups, local meetups, conferences, demo days, hackathons, etc. Partners also create deal flow partnerships between different VC funds, where entities share deals received from their networks. This drives collaboration between funds.
Researchers typically do everything related to research: token economics, business models, technical solutions, markets, etc.
Researchers are also often responsible for looking at the bigger picture and anticipating trends and narratives. For example, you might research a project that could become one of your portfolio companies.
That's great, but you can predict, for example, where the market is going to be 6-12 months from now and which companies can drive value there. So it gives you a better lens to look at the overall market situation rather than a specific protocol.
Advisors provide expertise and strategic guidance to venture capital firms and their portfolio companies. They typically serve as part-time advisors.
Their responsibilities include sourcing potential investments, conducting due diligence, and providing strategic advice to portfolio companies. Advisors share networks that connect startups to key resources and potential partners.
IR (Investor Relations) specialists at venture capital funds typically attract and maintain investor relationships. They work closely with the firm's partners to develop and execute fundraising strategies, create investor materials, manage communications, and other tasks. They often handle media inquiries, prepare for investor meetings, and track investor sentiment.
Every component of the team is important, and the GP’s key task is to ensure the team is working together and achieving its goals (in addition to overseeing fund strategy and overall performance).
Organizing transaction processes and strategies
Investing is hard, so we just let it happen? Well, that could be the case… but it’s too easy to let it happen. It’s better to leave a legacy for better performance so you can improve over time.
What do I need to do to evolve appropriately over time?
1. Put each startup into the legacy table. Make a list of competitors, their performance and valuations. A quick summary of each project will help a lot in the future when you have a database of 300+ startups to extract as many insights as possible.
2. Collaborate with colleagues to explore the best strategy for finding projects. When you are well-known enough, you usually don't need to do anything - startups will find you on their own. However, when you are growing, you have to be everywhere. Sniper hackathons, demo days, early groups, etc.
3. Don’t just snipe, be flexible. If you see a startup that’s not worth your attention, you can spot it in the first conversation, don’t waste your valuable time. If you see a startup that’s too good, and you know they’ll close the round soon — be as flexible as possible to get the best deal.
4. Increase your online exposure. For online content, publish articles that specifically focus on topics your fund is interested in. For example, Paradigm did a lot of research on MEV and ultimately invested in Flashbots (an R&D organization formed to mitigate the negative externalities caused by MEV).
What should you pay attention to when investing?
There are countless indicators you can rely on when investing or choosing the right investment, but when you have a deal in hand and the only question is whether to invest, there are probably a few parameters you should look for.
Token economics. Study inflation rates, emissions, payments to stakers (if that’s the case). The point is to avoid selling pressure and understand some strong mechanisms of the token to incentivize people to keep buying.
Technical/Fundamentals. This is probably the hardest subject to research. If you have a very complex project - you should find someone with expertise to outline what you should look for. Analyzing a collection of NFTs is easy, but understanding the mechanics of a separate L1 blockchain or developer SDK is much harder.
Competitors. Look for competitors to the protocol you might want to invest in. How are they performing? How much market share do they have? How are they different? Are they better or worse? In what way? By comparing them, you can learn more about the project you are researching.
Ecosystem. Typically, most protocols are based on only 1 ecosystem: Ethereum, Solana, some Layer 2, Cosmos, etc. The goal here is to see if a specific protocol fits into the ecosystem. For example, someone might build some farming protocol on Optimism. But there is no reason to do so because Optimism is not focused on DeFi. You have to look for such moments to ensure that the protocol can find its PMF (product market fit).
Investor research. If a project is doing a second or third round of funding, then they already have backers. You can research backers, they are usually divided into tiers, the smaller the tier, the better. For example, Multicoin is considered tier 1, it is one of the best VCs in the crypto space, and Outlier Ventures is about tier 4. You can see some funds in this table.
Team. Make sure all team members have relevant experience and a vision to build a successful project. Do they know what they are talking about? Are they smart? Do they fully understand the proposition? Would you feel comfortable if you were on the same team as them?
There are many more parameters like sentiment analysis, on-chain analysis, partner analysis, differences between pre-IPO and secondary markets. The tip here is to try investing unless there is evidence that the investment looks bad.
So find the parameters and indicators that prove this could be a good investment. If you can’t find any parameters and indicators, then this could really be a bad investment.
Summarize
Starting your own venture capital fund can be painful at first because setting up operations and processes is always stressful. If you've moved from one city to another, you know what I'm talking about. But it will get better in the end.
The goal here is to return the fund, for example, if the total capital you have to invest is $100 million and your average check is $1 million for 10% of the protocol, it only takes one unicorn for your share to be worth $100 million so that you can return the fund to investors.
Remember, investing is an art, marketing is an art, communication is an art, and research is an art. Keep practicing until you and your fund become one of the most famous artists.
