The Life Cycle Of A Venture Capital Fund
Funds begin with a capital-raising period where the venture capital firm seeks out investors for the new fund. Depending on the firms reputation, market conditions, and fund strategy, the process can take months or even years. Once the targeted funding amounts been reached, the fund is closed to new investors.
Afterward, the venture capital firm initiates a three- to five-year investment period in which the fund manager allocates the capital to investment companies and builds the portfolio. The focus shifts to managing the portfolio and providing the necessary resources to the investment firms to increase the odds of a profitable exit.
The total lifecycle of a venture capital fund lasts about seven to ten years, starting from the moment the fund is closed and ending once all deals are exited, and any profits are redistributed to the investors.
Why Is Venture Capital Important
Innovation and entrepreneurship are the kernels of a capitalist economy. New businesses, however, are often highly-risky and cost-intensive ventures. As a result, external capital is often sought to spread the risk of failure. In return for taking on this risk through investment, investors in new companies are able to obtain equity and voting rights for cents on the potential dollar. Venture capital, therefore, allows startups to get off the ground and founders to fulfill their vision.
Investing In Venture Capital Managers
Venture capital can be a lucrative business, and the professionals have a clear advantage over most individual investors. With large staffs that know industries extremely well and have negotiating credibility, venture capital firms have power that gives them a competitive edge over the typical funding source.
Because of this, some investors prefer to invest in the companies that provide venture capital rather than investing directly in the start-ups that those venture capital sources fund. Also, because some venture capital and private equity managers trade publicly, you don’t have to be an accredited investor or qualify for the crowdfunding regulation in order to invest in them. Among the names that are most popular in the space are Blackstone Group , Carlyle Group , and KKR .
The downside to investing in venture capital managers is that you can’t invest simply in one start-up. Even if the manager profits from working with a key new company, those gains will be diluted by the many other investments that the manager has made. However, some see that diversification as an advantage, allowing them to benefit from the general health of the venture capital space without having to decide which start-ups will be most likely to succeed.
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Venture Capital Vs Private Equity
Both venture capital and private equity are types of business financing that move money from the hands of investors into the accounts of businesses. And while the two have similar goals, their methods differ.
While private equity is another type of private business financing, it often involves the private equity firm buying 100% ownership of the company, while venture capitalists often remain minority investors. Private equity typically involves much larger investments for a significantly smaller risk.
Vc Is The En Vogue Asset Class
From humble beginnings, the venture capital industry has evolved into one of the most significant, and certainly best-known, asset classes within the private equity space. Venture-backed startups have redefined entire concepts of industry, with some of the trailblazers usurping the traditional oil and banking giants to become the most valuable companies on earth. The venture capitalists backing them have also taken their spot in the limelight, with the likes of Marc Andreessen, Fred Wilson, and Bill Gurley gaining recognition far beyond the confines of Sand Hill Road. You could compare this cult of personality to that of corporate raider era of the 1980s, when Michael Milken et al catalyzed the start of the LBO and junk-bond boom.
Partly as a result of this, the venture capital space has seen an influx of participants and professionals. First-time fund managers continue to raise new VC funds at healthy clips, and the once clear lines separating venture capital from private equity, growth equity, and other private asset classes have begun to blur. Corporates have also shifted into the space, creating venture arms and participating in startup funding at ever increasing levels. And perhaps the greatest sign of the times, celebrities are increasingly throwing their hats into the startup-investment ring. As John McDuling puts it,
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Understanding Venture Capital Funds
Venture capital is a type of equity financing that gives entrepreneurial or other small companies the ability to raise funding before they have begun operations or started earning revenues or profits. Venture capital funds are private equity investment vehicles that seek to invest in firms that have high-risk/high-return profiles, based on a company’s size, assets, and stage of product development.
Venture capital funds differ fundamentally from mutual funds and hedge funds in that they focus on a very specific type of early-stage investment. All firms that receive venture capital investments have high-growth potential, are risky, and have a long investment horizon. Venture capital funds take a more active role in their investments by providing guidance and often holding a board seat. VC funds therefore play an active and hands-on role in the management and operations of the companies in their portfolio.
Venture capital funds have portfolio returns that tend to resemble a barbell approach to investing. Many of these funds make small bets on a wide variety of young startups, believing that at least one will achieve high growth and reward the fund with a comparatively large payout at the end. This allows the fund to mitigate the risk that some investments will fold.
Real World Examples Of Venture Capital
Uber is an excellent example of a successful VC funding. Thus far the company has raised $12.9 billion in funding from venture capital in nine funding rounds. But the company has recently been valued at $68 billion. Thats more than five times the amount of VC funding and private equity investing in the company. Though Uber has not yet gone public, the venture capitalists stand to earn a huge windfall when it does.
An even better example is WhatsApp. This is a popular message app for smartphones. In April 2011, venture capital firm, Sequoia Capital invested $8 million in WhatsApp in exchange for a 15% share in the company. In February 2013, Sequoia Capital invested another $50 million in the company. At the time of the 2013 funding, WhatsApp was valued at $1.5 billion.
But then in 2014, lightning struck. WhatsApp was . Sequoia Capitals 15% equity stake was suddenly worth nearly $3 billion. Thats about 50-to-1 return on their venture capital investment of $58 million.
Of course not all VC fundings end happily. For example, venture capital firms and angel investors invested $108 million in the free mobile answering service provider ChaCha. But the company is now out of business, and the investors ended up writing off their investments.
You win some you lose some. But venture capital firms hope to win big enough on the successful deals to more than offset the more numerous losses they will suffer.
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Who Can Invest In Venture Capital Funds
Venture capital funds can cost millions of dollars to buy into, making them inaccessible to all but institutional investors and the extremely wealthy. ADDX, however, democratizes venture capital investing by making it available to investors for as little as S$10,000 to invest in primary offerings and as little as S$100 to trade.
To qualify as an ADDX investor, investors need to meet one or more of the following conditions:
Yearly income of at least S$300,000 or
Net financial assets of at least S$1,000,000 or
Net total assets of at least S$2,000,000
How Is A Venture Capital Fund Structured
- Management company. A management company is a business entity created by a venture firmâs general partners . Itâs responsible for managing a venture firmâs operations across its funds. The management company collects fees and pays expenses. It also typically owns the fundâs trademark and brand. Single-member companies, which are most common for new GPs, are treated as âdisregarded entitiesâ under U.S. tax code, while multi-member companies are treated as partnerships.
- General partner . In a limited partnership, there must be at least one general partner The GP is responsible for the active management of the fund and filing and signing the tax returns. The general partner has unlimited liability for the partnership.
- Limited partners . The fundâs limited partners are passive investors in the fund. Examples of LPs include pension funds, foundations, insurance companies, and wealthy individuals. The liability of limited partners is capped at the amount of capital the limited partner contributed to the fund.
- Portfolio companies. Companies the fund invests in.
Hedge Fund Vs Venture Capital Fund
Venture investing is different from other types of equity financingâlike mutual funds, the stock market, and hedge fundsâbecause VCs focus on a very specific type of investment.
With the stock market and mutual funds, investors back companies that tend to be much more mature and proven. Hedge funds typically invest across many investment categories.
This focus on early-stage by VCs companies produces high-risk/high-return profiles compared to other asset classes.
Due Diligence For Venture Capital Firms
The last item is kind of a catch-all that weâll call âdue diligence.â
When the venture capital firm gets more interested in a deal, the next phase of discovery is called due diligence. During this phase, theyâll dig into all the details of the business, from financials to the details of how the business model works.
This is where all of the research and support youâve put together will be put to the test. Theyâre likely going to ask you to prove how you arrived at the market size theyâre going after.
You may get asked to have your early customers talk to the venture capital firm. Assume the firm is going to do its best to make sure everything you said actually checks out.
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Prepare An Executive Summary And Basic Term Sheet
The next step in VC fund formation is to prepare an executive summary and a basic term sheet, which will outline the primary strategy, timelines, terms, and commitments. This is where the fund will disclose the terms by which management fees and carried interest will be allocated and paid out, and when.
The executive summary and term sheet should include the following:
- Description of basic terms for the fund
- Statement on the fund strategy
- Fund life and investment period
- Capital raise and closing period
- Minimum capital contribution
- Carried interest
Stages Of Venture Capital
During the venture capital process, many startups navigate through multiple stages or rounds of financing, including:
Seed: During this very early stage of development, entrepreneurs flesh out their business plan and often use seed capital for research and development to determine their product offering, target market and business strategy. Angel investors tend to be more involved here.
Early: As the business moves to scale production, operations and marketing, it can raise its first round of funding, called Series A. As the business grows and expands, successive rounds may follow.
Late: When the business prepares for M& A or an IPO, it may issue additional funding rounds to create the ideal market conditions for VC investors to exit the startup.
While VC firms compete to gain access to the best deals, they also support one another by investing together. Typically, several VC firms participate in each round of investment, with one firm serving as the lead investor and the others as secondary investors. This helps to enhance the credibility of the startup business and also spreads work and risk across various firms.
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What Are Venture Capital Firms
Venture capital firms are money management organizations that raise money from various sources and invest this collective capital into startups.
VCs raise these funds from family offices, institutional investors , and high net worth individuals , who allow the VC firm to manage their investments.
The size of VC investments in a given startup can vary widely based on the particular investment theory and practices of each firm.
The influx of VC cash, along with the additional resources, advice, and connections VCs can provide, often serves to help startups to grow rapidly and dominate their market.
VC firms typically make investments according to a particular thesis for example, supporting startups in a particular stage, industry, or geographic region.
Union Square Ventures is a notable VC firm toting a portfolio packed with big hits: Tumblr, Twitter, and Coinbase, to name a few.
USV invests according to a particular strategy, concisely summed up by partner Brad Burnham in a that became the firms official investment thesis: invest in large networks of engaged users, differentiated by user experience, and defensible though network effects.
This means that USV looks for companies that can scale , bring together huge groups of people or connect a marketplace , provide a seamless user experience , and thrive off of the network effect the more people who use it, the more valuable the tool is.
How Venture Capital Works
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America is known for its entrepreneurial spirit and leadership in innovation, but transforming a fresh new business concept into a viable business isnt easy. Many startups rely on venture capital to help provide both funding and expertise, with the hope of generating handsome financial returns if and when the business takes off.
Lets dive into the world of venture capital and how it works.
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How Does Venture Capital Work
Venture capital firms provide funding for new companies in the early stages of development. In return for funding, a VC firm takes an ownership stake thats typically less than 50%. A VC funds goal is to increase the value of the startup, then profitably exit the investment by either selling their stake or via an initial public offering .
There are four types of players in the venture capital industry:
- Entrepreneurs who start companies and need funding to realize their vision.
- Investors who are willing to take on significant risk to pursue high returns.
- Investment bankers who need companies to sell or take public.
- Venture capitalists who profit by creating markets for the entrepreneurs, investors and bankers.
Entrepreneurs looking for capital submit business plans to VC firms in the hope of obtaining funding. If the VC firm considers the business plan to be promising, it will conduct due diligence, which entails a deep dive into the business model, product, management, operating history and other areas pertinent to assessing the quality of the business and idea.
Regardless of how far along the business is, a VC firm also takes a deep look at the principalseverything from their education and professional experience to relevant personal details. Extensive due diligence is vital to making good investment decisions.
Venture : How To Get Into Venture Capital
Investors today fall into two categoriesâaccredited and non-accredited. Being non-accredited simply means an investor doesnât meet the SEC accreditation requirements, or in other words, that investor hasnât made $200k+ for the last two years or doesnât have at least $1 million in net assets .
In August 2020, the SEC passed amendments to the accredited investor definition, adding:
â¦a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order.
This addition gives the SEC a lot of leeway to continue expanding the definition so more folks can qualify as accredited investors. Itâs unclear how many investors now qualify, but itâs definitely a move in the right direction for this antiquated requirement.
If Youâre Accredited Youâve Got the Most Options
But Donât Worry If Youâre Not Accredited
Based on the definitions outlined before the amendments passed last summer, itâs estimated there are currently around 13 million households in the US meeting accreditation requirementsâabout 10% of American households. Even including the marginal number added by the updated definitions, itâs still a slim fraction of the retail investor population, so donât worry. Youâre not alone.
Investing with SPVs
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What Is Venture Capital Investing
Venture capital investing is a type of private equity investing that involves investment in a business that requires capital. The business often requires capital for initial setup . Venture capital investing may be done at an even earlier stage known as the idea phase. A venture capitalist may provide resources to an entrepreneurEntrepreneurAn entrepreneur is a person who starts, designs, launches, and runs a new business. Instead of being an employee and reporting to a supervisor because the former believes that the latter can come up with a great business idea.
How Risky Is Making A Venture Capital Investment
New companies often don’t make it, and that means early investors can lose all of the money that they put into it. A common rule of thumb is that for every 10 startups, three or four will fail completely. Another three or four either lose some money or just return the original investment, and one or two produce substantial returns.
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