How to Avoid Operational Debt: A Guide for Growing Venture Capital Funds
Over the years, I have been asked to prepare fee quotes and service offering proposals for numerous Venture Capital Funds. On almost all these occasions, I went into the proposal knowing that we were going to be too expensive for the Fund Manager and that there was no viable business model for us to provide services. Either the Fund Manager was on Fund II or Fund III, and potential investors were demanding a more mature operations model.
The challenge is that by this stage, inefficient operational habits have become deeply entrenched. Managers are often working from complex Excel workbooks that only one person in the organization knows how to navigate. Alternatively, they might be using a small CPA firm that does not specialize in fund services, resulting in a combination of QuickBooks and detailed spreadsheets that must be painstakingly pieced together before the administration can be transferred to a specialist provider.
The Side Letter Trap
To attract new investment, many VC Funds offer favorable side letter terms. However, these side letters quickly create reporting silos—demanding unique, bespoke reports for individual investors. This results in increasingly complex spreadsheets, an influx of investor queries (as investors undoubtedly have questions regarding the reports provided), and a compounding schedule of uncoordinated deadlines that put immense operational strain on a lean team.
For these reasons, the fee quotes we offer usually involve a heavy data cleanse and a complex data migration. In addition, the rapid ramp-up in investor count and the introduction of another set of fund processes put intense pressure on the manager. They need help, but they lack an investor portal and are not equipped to process the volume of AML in time for the first fund closing.
Building Operational Debt
VC Funds start with talented investors who have a great idea, but operating their own business comes with a hidden price: administration. At the early stages, founding partners are forced to roll up their sleeves and find stopgap administrative solutions to keep things moving. This is admirable and works just fine for Fund I, but managers inadvertently begin a process that will later require a costly untangling.
Investor services are managed through one or two individuals, and template notices are never established to be rolled over into Fund II. Hundreds of hours are poured into Excel workbooks, and short-term workarounds are deployed just to get to closing.
Consequently, Key Person Risk is significantly ramped up. Fund Managers begin to rely entirely on one or two key members of staff who know how to navigate the custom workbooks or complete a manual mail merge to distribute drawdown notices.
Then there are the softer administrative points, such as completing bank account applications for SPVs following a confirmed investment. Without these accounts in place, all money flows directly to the fund, requiring intercompany loans to be documented. This creates immediate downstream challenges with financial statement preparation and performance monitoring.
The Real Cost: Partner Opportunity Cost
Beyond the structural risks, there is a massive opportunity cost to consider. Every hour a brilliant VC partner spends chasing a signature on a board minute, fighting a bank onboarding portal, or manually mail-merging drawdown notices is an hour they are not sourcing deals, fundraising, or helping portfolio companies scale.
Opportunity cost ramps up dramatically over time as founders spend less time investing and more time either fixing administrative errors or inventing new, temporary processes from scratch.
The Fund I Dilemma
As Fund I matures, the operational stakes change, and each investment is structured and completed individually as managers seek to capitalize on market opportunities. Moving at speed in these situations is key, as they cannot lose these opportunities due to sluggish execution. In the absence of institutional systems and controls, a backlog of administration begins to build up. Documents are stored in inconsistent ways—or perhaps on personal desktops—and minutes are not always completed and signed for large transactions to demonstrate board approval. Managers may tolerate this chaotic administrative environment today, however this is not sustainable for future operations and fund managers begin to create problems for themselves in the future.
Often, the habits set in Fund I, inadvertently become the accepted way of working. High stakes deadlines are met, but the operational backlog continues to build up, and the future clean up task gets bigger and bigger.
Fund II – Continuing Bad Habits
By Fund II, the cracks are papered over. The team is bigger, the administration is busier, and nobody has time to rebuild what is already running. The operating model wasn't designed—it accumulated.
Large, complex spreadsheets get busier, investor CRM data is sporadically recorded, and a transaction execution process rolls forward which ultimately results in even more admin. Board minutes remain inconsistent. The investor portal is the same basic one from Fund I (if there is one at all), and the compliance framework hasn't been reviewed since formation.
The added challenge is that the fund is under more pressure to achieve returns as expectant investors have accumulated from Fund I. In addition, fund managers are still pushing for growth, hoping to get to Fund III.
Fund III – Realizing the Problem
By the time a Fund Manager hits Fund III, investors expect them to have graduated from the emerging manager status and are looking for an institutional enterprise. What they normally find however, is a spiderweb of workbooks tracking the fund’s Gross Asset Value (GAV), Net Asset Value (NAV), and performance metrics (IRR/DPI), running alongside an off-the-shelf QuickBooks system maintained by a local accounting firm. Allocators also know that information has been published manually in spreadsheets, which inevitably leads to formula errors, broken links, and miscalculated waterfalls. The investors are interested in finding the golden source of information, which often leads them to an independent specialist administrator, and if one does not exist, the allocator may flag an unmitigated valuation risk.
On the transactions side, allocators look for SPVs or portfolio investments executed at lightning speed without dedicated bank accounts set up concurrently, resulting in fund capital moving through a single master account with the promise of "sorting out the intercompany loans and ledger adjustments later”. They also look at controls around cash management, demanding a strict segregation of assets. Seeing SPV’s without bank accounts, and payments made without clear board resolutions may result in additional red flags raised during the Operational Due Diligence process.
Key person risk is another area sophisticated allocators will look at. Asking the question, if all operations are manually managed by one or two individuals, what happens if those individuals leave? Can you send out capital call notices at short notice? This is one of the key areas that leads managers to fund administrators.
Side Letter tracking (through a system not a spreadsheet), the corporate governance processes around decision making and compliance, and how you manage AML/KYC processes in the onboarding phase are other key areas the allocator will look at and potentially raise flags depending on what they find.
By the time allocators raise these red flags, the fix has become very expensive and incredibly complex. Fund Managers start looking to sophisticated administrators to help them reorganize and tidy up files and attempt to transition to institutional accounting software. Unfortunately, this sudden shift results in high operational friction and massive data-cleanse costs, leaving the fund manager scrambling to find an immediate solution and establish a baseline operational framework.
The Solution
If these problems resonate with you, rest assured you are not alone. I have worked with numerous fund managers in the past who need help bringing their operations up to a level expected of their new investors. Establishing a robust operational strategy and putting systems and controls in place early help to set the tone for future funds and helps managers reach an operational maturity that resonates with future LP’s. The longer it takes to implement a solution though, the more problems need to be fixed.
Partnering with specialized operational experts early helps establish institutional-grade policies and processes. In addition, implementing a centralized CRM for investor relations and a purpose-built investor portal can supercharge investor relations and significantly streamline investor comms. Picking the right investor portal can be challenging as this is not something you will want to change from fund to fund, but there are clear features to look out for which streamline closing operations and improve the consistency of investor comms – something managers will want to do as they scale up and launch new funds.
As a governance professional, I may be biased, but putting in place a robust governance framework is high on my agenda for improving emerging manager operations. Ensuring robust decision-making processes are in place for boards and committees can improve decision making, but also improves record keeping and consistency throughout the operational function. It also provides a clear record of risk management which is appealing to institutional investors. This can scare managers as it may seem like extra red tape to navigate, but if rolled out correctly, this can streamline those processes as key decision makers are not spending time establishing facts of the decision and energy is focused in the right areas.
AML/KYC is a key area to focus on. As Fund popularity increases, the number of investors needing to be identified goes up. This challenge is exacerbated when funds grow internationally, and new AML/KYC laws need to be considered. Outsourcing or co-sourcing the investor AML/KYC process and even the investor portal management can keep costs low whilst taking advantage of experienced and knowledgeable operational staff. Commissioning those staff to put in place systems and controls can establish successful frameworks for future funds and protect managers as they grow.
Also, modernizing templates and frameworks can help to future proof your fund operations, by establishing a toolkit which can easily be rolled into the next fund. These templates can be refined to fit investor needs and demands, whilst also being structured to easily fit into software platforms which will produce them in the future.
Conclusion
Partnering with Boldbridge means that Managers can focus on the value creation activities and leave the admin to us. Firstly, we focus our energy on managing the processes which impact your investor relations. We help choose the right investor platform, and manage the platform on your behalf, ensuring investor communications are managed in a consistent and professional way. Choosing a sophisticated investor platform early can set a tone for all future funds and is attractive to potential investors. We also manage CRM systems to ensure your investors, your clients, are looked after properly and you have a full record of your relationships with them – something that will be incredibly valuable when you get to Fund II and Fund III. Next, we will focus on your AML/KYC processes, ensuring investors are onboarded smoothly in compliance with local legislation. We also focus on establishing your Governance frameworks, ensuring decision making processes are in place and audit ready records are established. This is something investors will look on favorably when they complete their operating due diligence.
Operations often takes a back seat in the early-stage Fund Managers, and then fixing legacy problems can be a daunting and costly exercise if not handled correctly. Our focus is improving operations today but thinking about tomorrow. Everything we do will be with an eye on your growth and the potential to expand in the future. In essence, we reduce the operational debt.