This is an edited version of an article that originally appeared on Medium.

Newly formed VC firms are startups that are vying for success just like any startup they fund.

Like any startup, some will hit it big, some will return their money, and some will fade and evaporate.

After demystifying the VC firm value chain, entrepreneurs will better understand some of the motives of the VC firms they encounter. In addition, I hope some readers will be encouraged to start their own if they believe they can bring better value to the table.

A great strategic framework to analyze an industry is to look at its value chain. I divided it into five activities: funding, sourcing, investing, supporting, and exiting.

Funding

The goal of funding is to raise a VC fund from limited partners. This can be broken down to:

• Credibility: the VCs are now the entrepreneurs who will be pitching for funding from LPs. The LPs will look at their achievements, their track record, their investment thesis, and why them.
• Access: the LPs are usually banks, endowments, government or sovereign wealth funds, pension funds, foundations, high net worth individuals and family offices, and funds of funds.
• LPs sourcing: this is about researching, reaching out, scheduling meetings, and talking with LPs or firms who can help in the LPs sourcing.
• Raising: once identified, the agreement needs to be executed through a value chain of legal and financial activities.

Sourcing

One of the most important activities in the VC value chain is getting high quality startup deals.

In my opinion, it is best to have a filtering problem than a pipeline problem, but a way to influence the top of the funnel in the pipeline is to have a great brand strategy and messaging that will attract certain types of startups to you.

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Outbound sourcing is when VCs reach out to startups, and usually has a high startup acquisition cost.

• Outbound deal sourcing: the VC firm will use the network of its staff, advisors, mentors, portfolio companies/founders to go after promising startups and founders. Sometimes, the VC will be proactive in getting to the early stage startups, setting up student-led mini-funds with a presence on main university campuses (Dorm Room Fund by First Round Capital) or deal scouts at universities and startup hotspots (Sequoia Capital scouts). Other channels can be partnering with angels, syndicates, accelerators, and incubators for deal sourcing; networking and being close to the front lines; and mining sites like AngelList and Reddit for early tech ideas trends.
• Events: having a presence and/or sponsorship at main academia or industry events on startups and entrepreneurship, spotting, and following up.
• Network building: there are two parts of this network, the people sourcing the deals and the deals themselves. For the people sourcing the deals the questions are how to strategize, focus, coordinate, enable, and support.

In contrast, inbound sourcing is when startups reach out to the VC. Reaping such a dividend requires a consistent marketing strategy to build the brand of the VC firm.

• Content creation: It is usually experience driven  -  founders will be drawn to a particular VC due to their knowledge in a particular space, their experience, and the perspective they provide. The content can range from educational, to inspirational, to open discussions on future trends. One key differentiation, in my opinion, is the ability to connect with the audience by being genuinely empathic in intentions and humble in delivery.
• Publishing/distribution: this ranges from using social media, weekly or monthly email newsletters, a Medium channel or publication site, podcasts, or classes such as Stanford’s Blitzscaling by Greylock.
• Brand building: this is the sum of what you’re known for, what you stand for, your value proposition, and how you deliver it. It has to be nurtured through the VC value chain.

Investing

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Investing has art and science in picking winners. The spectrum shifts from art to science with the maturity of the startup.

I believe an inflection point in this mix is the stage of a startup before and after product-market fit. Before, the investors rely more on the founders, patterns, and qualitative indicators. After, there is data to quantify a startup’s business metrics and estimate what the company might be like in three to five years from now.

Another factor is the product market strategy fit, which is about the ability of the startup to capture, maintain, and protect from competitors the value it creates.

• Screening: this is a top of the funnel filtering. The powerful filter at this stage is the investment thesis, the guiding light of a VC firm. The investment thesis can be per market - fintech, healthcare, media, etcetera - business model driven, or business and product strategy, startup-stage, regional, market types, technology driven, or a combination of the above. In the future, data science will be used to pick potential winners.
• Due diligence: the process below can be used to assess startups which pass the first screening filter.

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• Term sheet design: the term sheet is a combination of risk management, negotiations, and navigating supply and demand with reservation boundaries on the terms. It has to be entrepreneur friendly, and/or the VC needs to educate and help the entrepreneurs in this process. It will be a partnership between both parties, and it is best if it starts on a solid and trusted foundation.
• Decision governance: some firms need a single general partner sponsorship, some have a voting approach, some are consensus driven. It pays to be provocative in supporting a contrarian idea which promises high returns if it turns out to be a contrarian truth. By definition, contrarian ideas are not consensus-friendly.
• Legal: this is an unsung hero in venture capital. It is also an evolving practice, keeping up with the lessons learned and the changes in the industry. In the Silicon Valley, there is a great symbiotic relations between the VC firms, new ventures, and corporate law firms. For a startup VC, it is crucial to establish and strengthen such partnerships early on.

Supporting activities

The goal of this activity is to support the growth of the startup after an investment is made. The spectrum varies across VC firms and is usually inversely proportional to the deals volume per firm due to limited resources.

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• Key partners: support can range from serving on the board to rolling up sleeves and being in the trenches when needed. A nice anecdote I like is when Andreessen Horowitz founder Marc Andreessen visited Brian Chesky at midnight when AirBnB was facing a PR crisis when a guest vandalized a host’s place. For a company designing trust as a product, it was an existential threat and Marc’s input played a pivotal role. In moments of crisis (common for a startup) knowing that you can get such quality support, even at midnight, is invaluable. For entrepreneurs, use that as a litmus test when evaluating your relationship with your lead investor.
• In-house experts: depending on the size of the fund, the firm might include in-house experts. A16z and Google Ventures are among the leaders in this aspect.
• Network: the firm can grow its support services by tapping into a loosely coupled network of experts, partners, and community. YC is an example of community where there is tremendous esprit de corps among its alumni to support each other and share lessons learned.
• Process formation and streamlining: I have seen accelerators build a mentor network just for show but with little value extracted from it. This activity needs to be measured and continuously improved. It is important to have the right governance structure in place on how to grow, measure, and improve this activity of the value chain.

Exiting

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Venture capital is a business with a day of reckoning when the VCs need to close their fund, mostly after 10 years, cash out and return the money to LPs.

For entrepreneurs, it is important to understand this aspect of the business.

VCs want home runs, they want to farm black swans. As they need at least a 20-25 percent internal rate of return (IRR) on their fund. As statistically a third of their deals fail, a 25 percent IRR per deal won’t cut it. They need to see that you can make a dollar out of 15 cents.

As the day of reckoning approaches, it puts pressure on their startups’ CEOs to get to a liquidity event.

• Identifying ways to exit: the main options are acquisitions and IPOs, with a few instances of exiting through secondary markets or existing shareholders. If the startup is under financial distress and the prospects for acquisition or IPO are just not there, then it might have to raise mezzanine or private equity financing. This can subject it to a debt holders takeover where ownership and board decision making will change and shift away from the founders and the VCs.
• Finding a buyer or underwriter: for acquisitions it is better for a startup to be bought than sold. Being bought commands a premium, being sold comes with a discount. For IPOs, if and when the startup is ready, the VC can help in finding an investment bank as an underwriter, and support the startup and its Board in the IPO process.
• Executing: this is mostly the work of the ecosystem of this value chain, investment bankers, lawyers, regulatory authorities, etc.

Everything being equal, entrepreneurs care about the supporting they will receive when picking the VC. The LPs care about the outcome of the exit, and the VCs care about the whole end-to-end value chain, with the investment activity their most crucial and idiosyncratic component.