An Introduction to Venture Capital Fund

An Introduction to Venture Capital Fund

Venture capital is a key source of funding for high growth startups across the planet, and hence plays a vital role in spurring job creation and economic productivity. Some of the biggest companies in the world, in fact, started with funding and advice from venture capitalists (VCs). Moreover, Venture-backed companies constitute nearly half of IPOs in the United States.

Earlier, Anand Jayapalan had spoken about how venture capital basically is a form of private equity that funds early stage emerging companies and startups that have little to no operating history, but considerable potential for growth. Several fledgling enterprises sell ownership stakes to venture capital funds in return for financing, technical support as well as managerial expertise.

Venture capitalists tend to make risky investments in startups in the hopes of outsized returns, which is happening with greater frequency. Over the last decade or so, the domain of venture capital has experienced substantial growth and innovation. Today a rapidly growing number of venture capitalists are investing more capital than ever.  A venture capital fund may mean many things, right from a traditional fund that invests in a portfolio of companies over a 10-year horizon to a Rolling Fund that accepts quarterly commitments.

Venture capital funds earn returns for investors in a variety of ways. In the most common situation, a fund will receive returns following a “liquidity event,” like an acquisition from another company or an initial public offering (IPO). The proceeds shall subsequently be distributed among the investors of the fund on a pro rata basis.

The manager of a venture capital fund is usually referred to as the “general partner” (GP). A GP tends to be responsible for raising funds from a network of investors, choosing investments, as well as overseeing all of the operational, accounting, and legal aspects of the fund. The GP typically follows an investment thesis in order to select investments, and target a particular specific segment of the market and/or stage of investment. Investors in a venture capital fund are generally known as “limited partners” (LPs). They typically are high-net-worth individuals or other financial institutions wanting exposure to the venture asset class.  Earlier, Anand Jayapalan had discussed how venture capital funds generally invest in a variety of startups, expecting some to fail, and hope for a handful of big winners. The general time horizon for most venture investments is six to ten years.

Venture capital plays an important role in the success of many modern companies.  A large percentage of money invested by venture capitalists goes into building infrastructure necessary to grow the business.  Apart from capital, several venture fund managers also provide guidance to portfolio companies. Several VC firms actually have a good reputation for assisting portfolio companies with customer acquisition, recruitment, access to follow-on funding, and advice on other challenges startups encounter.

Venture capital returns follow a power law distribution, meaning that one highly successful investment in a portfolio can yield significant returns for the entire fund. Funds typically invest in numerous companies, anticipating that some will fail while hoping that a few will achieve substantial exits that compensate for the losses and “make” the fund.