The most basic definition of Venture Capital is the fund that provides seed capital for an early stage startup. The fund is responsible for monitoring the company, providing funding for subsequent rounds of funding, and exiting when the startup reaches a liquidity event, such as an IPO or acquisition. Returns from venture capital funds tend to follow a power law distribution, with one homerun investment generating outsized returns for the fund. VC funds tend to invest in several companies, and many of them will fail, but the goal is to make the fund as a whole.
In the early days of venture capital, wealthy investors were the only people who could invest. Some of the first investors included the Vanderbilt and Whitney families, who invested in Swedish companies and later became prominent in the VC industry. In 1958, the US Labor Department eased ERISA restrictions on ‘prudent-man’ investing, which resulted in a boom in the industry. The NASDAQ Composite index reached a high of 5,048 in the same year.
Although VC funds tend to concentrate their investments in twenty or forty companies, it would be beneficial to expand the average portfolio size to fifty to 100. That would help offset the increased startup attrition that many VCs experience. By increasing portfolio size, VCs can increase their chances of seeing success. For example, doubling the average VC fund’s portfolio size would improve the performance of the entire industry. However, this would require a significant amount of time and money to accomplish.
Before deciding whether to invest in a particular business, it is essential to prepare a detailed business plan. The pitch deck contains a brief description of the technology or concept, while a comprehensive business plan explains the financials. Once the business plan is ready, VCs move to due diligence. This process involves a thorough check of the business plan’s statements and assumptions. After due diligence, a potential investor may offer a term sheet.
LPs make money from venture capital funds when the company they’ve invested in goes public or is acquired by a third party. The funds also make money when the companies they’ve invested in are sold to another investor in the secondary market. LPs and venture capital funds make money by charging a percentage of the assets they manage or by selling shares to another entity. The funds also pay their employees incentives for better returns. But the best part about VC funds is that they’re a great source of startup funding.
Aside from enabling businesses to develop, venture capital has helped the United States support entrepreneurial talent by transforming basic research into valuable products and services. Companies created by venture capital funds typically take five to eight years to mature from start-up to free-standing organizations. This gives them a longer runway to success. It’s also important to understand that VC funds use different tools to evaluate untangible businesses. However, many of these investors use the same tools.