VENTURE CAPITAL - HOW DOES A VC FIRM WORK ?
Today there is huge amount of money in the market of startup funding across all stages of funding. Although there are lot of financing options for startup businesses available but it’s up to the investor or the owner to decide which option is to be considered. One such option is venture capital, so let’s get an idea about the elephant in the room namely Venture Capital firms.
Venture Capital is a type of financing which is self-explained. Actually it has firms or funds that offer venture capital which is high risk capital supporting organizations and companies with the hope that they will provide a huge return on investment (ROI).
Working of Venture Capital firm
Within a Venture capital fund, there are two main elements: limited and general partners. People who are in charge of taking investment decisions as well as work with startups business for growing and meeting their goals are called as general partners. On the other hand, those who give required capital necessary for completing those investments are referred as limited partners. One can also say that limited partners offer the funds while general partners do the investments.
One of the major differences among Venture Capital funds and other investment vehicles is that Venture Capital funds do not invest own partners’ money in case of limited partners while general partners use to invest few of the amount through the fund which is approx 1% of the fund.
How Do Venture Capital Firms Make Money?
A venture capital fund makes money in two ways: carries (carried interest) and management fees.
Carry or carried interest: It is a profit share of an investment fund or investment paid to the manager in surplus of the amount that he contributes to the partnership. In Venture Capital, carried interesting is mainly 20-25 %, which means the profit percentage among limited and general partners is 20% and 80% respectively.
Management fees: It is usually termed as the ‘cost of professionally managed assets’. Typically, venture capital funds pay management fee annually to the fund’s management company, in the form of salary and a method to cover fund and organizational expenses. It is usually computed on a capital commitments percentage of the fund which is about 2-2.5 %.
Influence on Startups
It is very important that business startups should identify the working of Venture Capital firms. Investors with one key objective in mind back startups for getting a ROI either in the form of money. It’s also important to note that Venture Capital funds have 10 years of fixed life, thus creating investment cycles lasting for about 3-5 years. After this firm start working alongside the business startups and the owners will scale & seek an exit, giving the returns they sought initially. Moreover, there is enough potential in venture capital firms, but it is essential to make sure that the chosen path is right for business startup. Venture capitalists in exchange for the high risk they have taken by investing in your company, they basically get considerable control on decisions of the company. Venture can surely be a smart option for business startups that are willing or unwilling securing bank loans or completing debt offerings.
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