Venture capital is the investment made in high-growth potential startups and growing companies where regular banking institutions are shy of investing. The venture capital is on a broad level worked out in three processes.
Fundraising
Venture capital firms are responsible for the end-to-end ownership of the funds. VC firms do not have the required funds within them. They get the funds that they want to invest by raising from various sources, primarily institutional investors and high-net-worth individuals. These entities from where they raise funds are called limited partners. Institutional investors are entities like insurance companies, endowment funds, and pension funds. High net worth individuals are the people who are wealthy individuals and are looking to invest their money.
VC firms go through a fundraising process, where they pitch to potential investors showcasing their strategy, previous track records, and exits. They showcase the investment focus and have a target fund size. Different VC firms have different investment focus. It can be but is not limited to, sectors, geographies, or industries. This is similar to a startup raising money.
The conclusion of the fundraising process is the limited partners committing a specific amount of money for a time period. This capital is given to the VC firm when an appropriate investment opportunity is recognized. This process is called capital calls.
Fund management
A typical VC firm has analysts, associates, and partners who consist of their investment team. An analyst supports the investment team with research, data analysis, and administrative tasks. An associate supports the investment team in sourcing deals, conducting market research, and performing due diligence on potential investments. A partner leads the investment and negotiates the deal with startups. A managing partner sets the overall strategy and is responsible for fundraising.
A venture capital firm has a typical investment period. They invest in startups during this time according to their strategy of investment. After they have made the investment in a company they offer their expertise in various parts of a startup’s journey like marketing, development, and legal. For this active management and guidance to the investee companies, they have a whole network of experts in their fields.
To manage these expenses, a VC firm charges a management fee for the operational expenses. This is typically a percentage of the committed capital. They also receive a carried interest which is a percentage of profits generated by the fund.
Fund exits
All the VC funds have their lifespan. Within this lifespan, they help with all the support for a company that is required for them to grow. A typical lifespan of a fund is about 10 years, after which the exits are expected. There are various types of exits that the VC fund makes from a startup like IPO, acquisition, or direct profits. While a startup raises funds from the VC, these potential exits are discussed, as it is an important part of the strategy. As the portfolio companies grow and mature, the way to plan exit for the VC starts.
VC firms regularly demonstrate the progress of the fund to the investors. Reports and performance status of the fund’s progress are updated to the investors at a regular cadence. Once the investments are successful, they are distributed between the limited partners and the VC firms according to the agreed terms.
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