The easiest way working with and for venture capital funds is becoming a scout and being compensated for sourcing investment. But how do you do that?
We studied VC scout programs not only to improve our deal sourcing, but for four more general reasons:
1. To help our founders in transition
Versatile VC runs a free community for founders in transition, “Founders’ Next Move”. We’ve gathered a wide variety of resources for founders who may be considering starting a new business; angel investing/becoming a VC; buying a business; joining shelves; consult; acting as interim executive; or just get a job. Our goal is to invest in, co-invest with and/or recruit founders in transition.
2. Monetize our deal flow
All VCs, including us, regularly see investment opportunities that do not fit our mandate. We might as well be compensated for referring others. There are a number of venture capital funds that share the carry earned in their co-investment with the referring party. Another option is for us to become a formal scout for other VCs through programs such as the programs below.
3. We are launching our own scout program and want to compare the pay and structure with that of our colleagues
We already have a senior team of venture partners assisting us in the genesis and due diligence. They may also consult directly with companies or serve on boards of directors. In that case, we will arrange for them to be compensated directly by the relevant company. Scouts are meant to be a lighter relationship, focused only on sourcing. We envision that we can have an unlimited number of scouts, but only a small number of Venture Partners.
4. Scouts Help Diversity in VC. to improve
This applies to both the investor side and the management of portfolio companies.
What really matters is the fit of the scout fund. You won’t make money if the type of investment you’re making isn’t right for the VC you’re looking for.
We have identified a number of VCs alongside us who have publicly discussed their scouting programs and in some cases shared their economy publicly. We found these by searching company websites, social media, blog posts, etc. We list them all below.
Keep in mind that, in addition to formal scouting programs, many VCs will make one-time arrangements with “friends of the company” to compensate them for sourcing. You normally cannot “apply” to those relationships unless you have a pre-existing relationship with the VC.
How much can you earn?
Scouts usually get a percentage of the carry-on investment they buy. So excluding cash upfront, your cash compensation, which is normally paid out when that startup closes (usually three to 12 years from the present), is equal to:
# companies you source
* (% of companies in which the VC invests)
* (average VC check size)
* (average multiple generated, minus 1)
* (your percentage of the carry pool, typically 2.5%-10% of the fund’s carry pool on a given investment, ie of the typical 20% the fund earns)
If you are paid per deal, your contract may include adjustments for carry settlement. For example, if the total fund is a multiple of 0.9X, you may get paid zero even if you purchase a winning investment for that particular fund.)
Certain late stage VCs have invested in some of my past funds, in part to motivate us to refer future investment opportunities to them. A few companies also or instead pay a cash premium to scouts, usually 1% of the amount invested in the company. Alternatively, some companies pay a fixed percentage of the total fund carry per deal found, i.e. if you buy one company out of a planned 30 companies in a fund, you may get 10%*(1/30) = 0.333% of the carry pool. This structure has the advantage of simplifying accounting and motivates the scout to be a resource for the entire portfolio, not just the one company it found.
A few funds (eg Accel, Sequoia) give the explorer a small pool of capital. In fact, the explorer then manages a small pocket of that venture capital fund. Typically, the supporting VC will have some ability to veto the explorer’s investments in this structure.
That said, a generous carry rate is irrelevant if the fund’s stats for the other components of the above formula are low. What really matters is scout fund fit† You’re not going to make money if the kind of investments you make don’t suit the VC you’re looking for because they just won’t put money to work.
Some scouts also have the opportunity (or expectation) to help raise money for the fund by soliciting fund pledges from potential LPs. Typical fundraising incentive payments from VC limited partners is 0.5%-2% of the money raised, with larger percentages for smaller funds. Contact legal counsel to ensure these compensation structures are consistent.
Other investors paying redemption fees
Our focus here is on venture capital, but the private equity sector also has team members focused on origination. These are mainly full-time team members, but PE funds also employ investment banks and freelance ‘finders’.
Including bonuses, the salary for a new business development employee at a private equity firm is approximately $100,000. Some PE funds publicly advertise rewards for anyone who directs them to an investment, while independent sponsors can earn a 20% fee for facilitating deals.
Likewise, certain income-based financial investors also have open access scouting programs.
“Given the instantaneous nature of RBF, the payout is instantaneous: a successful hookup typically generates up to 1% of the amount raised to the finder,” noted OpenVC CEO Stephane Nasser. “If you have access to post-sales SaaS or e-commerce businesses, you can easily make $1,000 to $10,000 per business in just a few days.”
Most scouts are paid on the basis of success only, with no commission. If it’s your responsibility to just forward emails and make the occasional intro, it’s less common to get a commission. You can argue for a commission (or an investment in your fund, if you are a VC yourself) if any combination of the following applies:
- You will spend a lot of time on marketing, sourcing and filtering investments, in addition to your normal business activities. If you work an hour a week, most people feel comfortable knowing that they might not get paid for another ten years. But if you’re working more than an hour a week, ask for more certainty about cash and/or fair compensation. I suggest clarifying the number of hours/week you expect to work, and multiplying this by what you consider a reasonable hourly rate.
- You will be involved in other aspects of the firm’s operations: due diligence, portfolio acceleration, board service, etc.
- You are prominent enough that your affiliation with the company generates brand equity.
How do you find a scout job?
Scouts are typically hired because they are well-networked and credible in an industry, geography, and/or community a VC is targeting. Joel Palathinkal, CEO of Sutton Capital, notes that scouts usually fall into one of three categories: