Venture capital (VC) is financial capital provided to early-stage, high-potential, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as biotechnology, IT, software etc. The typical venture capital investment occurs after the seed funding round as growth funding round (also referred as Series A round) in the interest of generating a return through an eventual realization event, such as an IPO or trade sale of the company.
Venture capitalists typically assist at four stages in the company's development:
- Idea generation;
- Start-up;
- Ramp up; and
- Exit
Structure of the funds
Most venture capital funds have a fixed life of 10 years, with the possibility of a few years of extensions to allow for private companies still seeking liquidity. In such a fund, the investors have a fixed commitment to the fund that is initially unfunded and subsequently "called down" by the venture capital fund over time as the fund makes its investments. Venture capitalists are compensated through a combination of management fees and carried interest (often referred to as a "two and 20" arrangement):
- Management fees – an annual payment made by the investors in the fund to the fund's manager to pay for the private equity firm's investment operations
- Carried interest - a share of the profits of the fund (typically 20%), paid to the private equity fund’s management company as a performance incentive. The remaining 80% of the profits are paid to the fund's investors.
Where do venture capital firms obtain their money?
Just as management teams compete for finance, so do venture capital firms. They raise their funds from several sources. To obtain their funds, venture capital firms have to demonstrate a good track record and the prospect of producing returns greater than can be achieved through fixed interest or quoted equity investmentsVenture capital firms' investment preferences may be affected by the source of their funds. Many funds raised from external sources are structured as Limited Partnerships and usually have a fixed life of 10 years.
Making the Investment - Due Diligence
To support an initial positive assessment of your business proposition, the venture capitalist will want to assess the technical and financial feasibility in detail.They will assess and review the following points concerning the company and its management:
· Management information systems
· Forecasting techniques and accuracy of past forecasting
· Assumptions on which financial assumptions are based
· The latest available management accounts, including the company's
· cash/debtor positions
· Bank facilities and leasing agreements
· Pensions funding
· Employee contracts, etc.
The due diligence review aims to support or contradict the venture capital firm's own initial impressions of the business plan formed during the initial stage. References may also be taken up on the company.