Venture Capital Firms
Venture capital is high-risk, high-return investing in
support of business creation and growth. In pursuit of
high returns, a venture capital ("VC") firm
raises a fund of anywhere from $10 million to $350 million
in size for their first fund. Later these funds may grow
to the billion dollar size and above.
The legal structure of a VC fund is a limited partnership,
limited liability company or limited liability partnership.
Those who invest money into the fund are known as limited
partners (LPs). Those who invest the fund's money in developing
companies, the venture capitalists, are known as general
partners (GPs). Generally, the LPs contribute 99% of the
committed capital of the fund while the GPs contribute
1% of it. As returns are made on the fund's investments,
committed capital is distributed back to the partners
in the same percentage.
VC firms receive compensation for their investment and
management activities in two ways. First, they receive
an annual management fee paid by the fund to a management
corporation which employs the venture capitalists and
their support staff. The annual management fee approximates
2.5% of committed capital; however, it is usually lower
at the beginning and end of the fund when investment activity
is low. The VC firm also receives compensation through
the allocation of the net income of the fund. The fund's
primary source of net income is capital gains from the
sale or distribution of stock of the companies in which
it invests. The GPs typically receives 20% of net capital
gains while the LPs receive 80%.
A venture capital fund passes through four stages of
development that lasts for a total of about ten years.
The first stage is fundraising. It typically takes the
GPs of a venture fund six months to a year to obtain capital
commitments from its LPs. LPs include state and corporate
pensions funds, public and private endowments, and personal
The second stage lasts between three and six years and
is comprised of sourcing, due diligence, and investment.
When a VC firm sources a company, it means that the company
has been brought to the attention of the firm. Sourcing
occurs through reading trade press, attending trade conferences,
and speaking to those with industry familiarity. A junior
member, a.k.a. an Associate or Analyst, spends the majority
of his/her time sourcing companies. After a GP or junior
member sources a prospective deal, extensive research
is done on the company and its market. Occasionally this
process, called due diligence, leads to an investment.
Companies in which VC firms invest become "portfolio
The third stage, which lasts until the closing of the
fund, is helping portfolio companies grow. The portfolio
company and the VC firm unite to form a team. This team's
goal is to increase the value of the portfolio company.
The VC firm becomes an equity participant in the portfolio
company through a deal structure typically comprised of
a combination of stock, warrants, options, and convertible
securities. In return, the VC firm provides financing
and a representative who sits on the portfolio company's
board. As a board member, the VC representative offers
strategic advice to the management team and assures that
his/her firm's interests are considered.
The fourth and final stage in the life of a venture fund
is its closing. By the expiration date of the fund, the
VC firm should have liquidated its position in all of
its portfolio companies. Liquidation usually occurs in
one of three ways: an Initial Public Offering (IPO), the
sale of the company to a third party, or Chapter 11. Typically
an IPO realizes the greatest return on investment.
By Venture Planning Associates