How the fund mandate of a venture fund constrains business operations and decision-making

When an entrepreneur accepts funding from a venture capital (VC) fund, they are entering into a relationship where they must not only consider the financial and strategic interests of the business but also the specific constraints and guidelines set by the fund's mandate. The fund mandate governs the fund’s investment strategy, objectives, risk tolerance, and return expectations. This mandate, therefore, shapes the decisions that entrepreneurs can make and imposes limitations on how they run their business. Entrepreneurs must be aware of these constraints and remain aligned to the fund's objectives to ensure that they can continue to access future rounds of funding and maintain a positive relationship with their investors.

Understanding the fund’s mandate

A fund mandate refers to the set of criteria, goals, and strategies that a venture capital firm will have proposed when raising capital from its investors. This mandate often reflects the fund's focus on particular industries, stages of investment, geographical regions, duration of holding and expected return on investment. The mandate reflects the interests and risk appetite of the investors as well as the fund’s general investment philosophy. A typical VC fund will have a mandate to invest mainly in early-stage tech startups with the potential for higher growth and an expectation of delivering a multiple return on the investor’s stake. In contrast, a Private Equity fund might focus on later-stage investments in more established companies with stable cash flows, a clearer path to profitability but with a much lower multiple of return. The different natures of fund mandates can significantly affect how an entrepreneur runs their business because the VC will expect the company to align with their mandate. Any deviation could trigger a re-evaluation of the partnership or limit the entrepreneur’s access to additional capital.

Constraints imposed by the fund mandate

Once the funding is accepted, the entrepreneur becomes bound by the tactical and strategic parameters of the fund’s mandate. These constraints can manifest in several key areas, including business model, growth trajectory, target markets, exit timing, and financial goals:

1. Business Model and Industry Focus

If the venture fund has a specific industry focus—such as fintech, healthtech, or cleantech—the entrepreneur’s ability to pivot or explore new markets may be limited. For instance, if the entrepreneur discovers an untapped market outside the fund's designated focus area, pursuing it could violate the fund’s mandate, potentially leading to a reduction in support or additional funding. The entrepreneur’s business model must align with the investment thesis of the fund. For example, if the fund targets high-growth tech companies, the entrepreneur will likely be pressured to focus on scaling quickly and developing a technology-driven product rather than a more traditional, lower-growth business.

2. Growth expectations and pace

Venture capital funds typically invest with the expectation of rapid, scalable growth in mind. The fund mandate will likely emphasize the need for the entrepreneur to prioritize high growth over other considerations, such as profitability in the short term. This could manifest in demands for aggressive customer acquisition strategies, international expansion, or large-scale hiring. As a result, entrepreneurs may be constrained in how they grow their company, particularly if they would prefer a slower, more sustainable growth model. The need to meet ambitious growth milestones can also affect strategic decision-making. For instance, an entrepreneur may be pushed to prioritize quick market penetration at the cost of product development or operational efficiency, simply to satisfy the fund’s growth targets.

3. Exit strategy and timelines

The fund’s mandate often includes specific preferences for how and when the venture should exit. Many venture funds focus on achieving a liquidity event within a set timeframe (typically to a maximum of 5–7 years) through a sale, merger, or rarely these days, IPO. Entrepreneurs must factor this pressure into their strategic planning, as the fund will expect an exit strategy that aligns with these timelines. If the entrepreneur has any reason to pivot from their original plan to one with a longer time horizon, this misalignment can create friction with the fund. As a result, the entrepreneur may find themselves needing to adjust their vision, product development, or organizational structure to meet the fund’s desired exit timeline.

Moreover, funds may have specific preferences for the type of exit. Some funds may prefer a strategic trade sale, where the company is bought by a larger player in the industry, while others may be more inclined toward an IPO. Entrepreneurs need to be prepared to navigate these preferences and adjust their planning accordingly.

4. Risk appetite and financial constraints

Venture capital funds typically invest with a high appetite  for risk, but they also have certain financial constraints. These constraints could include limits on the total capital allocation per investment or requirements around financial performance benchmarks (e.g. sales figures, revenue growth). Most fund managers will sit on the board and the entrepreneur will face additional scrutiny in decisions that involve large capital expenditures, debt, or risky product innovations. The entrepreneur might also be expected to scale rapidly and generate financial milestones, sometimes at the expense of other priorities such as customer experience or quality control. Funds will often expect startups to reach pre-agreed milestones at regular intervals to demonstrate that the business is on track. If the entrepreneur’s business model doesn’t meet these financial milestones, the fund might restrict future funding or apply pressure for a strategic pivot. This can limit flexibility in how the entrepreneur allocates resources or prioritizes certain aspects of the business, particularly during challenging periods.

5. Governance and decision-making

The fund mandate can also influence the entrepreneur’s decision-making power. Many venture funds demand significant governance rights, such as board seats, veto rights, or other decision-making authority usually contained within the consent matters in the Shareholder’s Agreement. This will constrain the entrepreneur by requiring them to seek approval for major strategic decisions—such as hiring, raising additional funds, or making changes to the business model. If the entrepreneur disagrees with the fund’s preferences on key decisions, there may be conflicts over direction, which could slow down the execution of business plans or force the entrepreneur to align with the fund’s priorities.

Staying Aligned with the Fund Mandate

To successfully navigate these constraints, entrepreneurs must stay aligned with the venture fund’s mandate in their planning and decision-making processes. This alignment requires continuous communication with fund managers and their investors and an understanding of their goals and priorities. Entrepreneurs should ensure that their long-term vision for the company is compatible with the fund’s exit timeline, risk appetite, and growth expectations. Regular check-ins with the investors and transparency about business challenges or changes in strategy can help maintain trust and keep the relationship on track. Entrepreneurs should prioritize developing their business in a way that aligns with the fund’s target market and industry focus, while still allowing for some flexibility and innovation. By demonstrating an understanding of the fund’s mandate and integrating these objectives into their day-to-day decision-making, entrepreneurs can position themselves for continued support and future funding rounds.

Conclusion

The fund mandate of a VC fund serves as both a guiding framework and a set of constraints for entrepreneurs who take money from that fund. Entrepreneurs must be mindful of the restrictions set by the mandate, as these will influence critical decisions related to growth, industry focus, financial strategy, and exit timing plans. Maintaining alignment with the fund’s objectives is essential for securing ongoing support and achieving the desired outcomes for both the entrepreneur and the investor. Understanding and navigating these constraints effectively is a crucial aspect of building a successful business supported by venture investment.