Business, Legal & Accounting Glossary
Venture Capitalists are professional money managers who provide risk capital to businesses. Venture capitalists come in many forms and specialize in different ways, but all share the common trait of making investments in privately held companies that have the potential to provide them with a very high rate of return on their investment.
Venture capitalists include thousands of private funds, companies funded by public offerings of their securities, bank and corporate subsidiaries charged with investing budgeted funds, and private individuals, who are often called “adventure capitalists” or “angels.” Venture firms can be highly leveraged companies, such as SBIC’s and SSBIC’s, or completely unleveraged.
A venture capitalist (VC) is a type of private equity investor who invests in high-growth firms in exchange for an ownership share. This could include investing start-up projects or assisting small businesses seeking expansion but lacking access to equity markets.
Venture capital firms are often organised as limited partnerships (LPs), with the partners investing in the VC fund. The fund’s investment decisions are often made by a committee. Once prospective rising development companies have been identified, the pooled investor capital is used to fund these firms in exchange for a large equity interest.
Contrary to popular opinion, VCs do not typically support firms from the start. Rather, they seek to target companies that are in the process of commercialising their idea. The VC fund will invest in these companies, nurture their growth, and attempt to exit with a significant return on investment (ROI).
Venture capitalists often seek companies with a strong management team, a large potential market, and a distinctive product or service with a significant competitive edge. They also hunt for opportunities in sectors they are familiar with, along with the opportunity to own a big share of the firm and so influence its path.
Venture capitalists are willing to take a chance on such businesses since they stand to gain a big return on their investment if these businesses succeed. However, venture capitalists have a high failure rate due to the inherent uncertainty associated with new and unproven businesses.
Wealthy individuals, insurance firms, pension funds, foundations, and corporate pension plans can pool their funds and invest in a venture capital fund managed by a venture capital firm. While each partner owns a portion of the fund, it is the venture capital firm that determines where the money is put, which is typically in enterprises or ventures that most banks or capital markets would deem too risky to participate in. The general partner is the venture capital company, while the limited partners are the other companies.
Management fees and carried interest are paid to venture capital fund managers. Approximately 20% of profits are distributed to the company that manages the private equity fund, with the remainder going to the limited partners who invested in the fund. General partners are typically subject to an extra 2% fee.
In the United States, the first venture capital firms began operating in the mid-twentieth century. Georges Doriot, a Frenchman who travelled to the United States to get a business degree, taught at Harvard’s business school and worked at an investment bank. In 1946, he founded American Research and Development Corporation (ARDC), which would become the first publicly traded venture capital business.
ARDC was groundbreaking in that it enabled startups to raise capital from sources other than affluent families for the first time. Historically, new businesses sought funding from affluent families such as the Rockefellers or Vanderbilts. ARDC quickly accumulated millions in funds from educational institutions and insurance. Alums of ARDC formed firms such as Morgan Holland Ventures and Greylock Partners.
Following the 1958 Investment Act, startup financing began to resemble the present venture capital business. The statute authorised the Small Company Association, which had been created five years prior, to licence small business investment corporations.
By definition, venture capital invests in innovative enterprises with a great potential for growth but also a level of risk that scares away banks. Thus, it’s unsurprising that Fairchild Semiconductor (FCS), one of the first and most successful semiconductor businesses, was the first venture-backed startup, establishing a precedent for venture capital’s strong engagement with new technology in San Francisco’s Bay Area.
Private equity firms in that region and time period also established the standards of practise employed today, establishing limited partnerships to hold investments in which experts served as general partners and individuals providing funds as passive partners with less power. The subsequent decade saw a growth in the number of independent venture capital businesses, prompting the formation of the National Venture Capital Association in 1973.
Since then, venture capital has evolved into a $100 billion business, with total investments totaling $238.7 billion as of Q3 2021.
6 Among today’s prominent venture capitalists include Jim Breyer, an early investor in Facebook (FB), now Meta, Peter Fenton, an early investor in Twitter (TWTR), and Peter Thiel, co-founder of PayPal (PYPL).
The responsibilities inside a venture capital firm are organised differently depending on the organisation, however they can be divided into three categories:
VC firms often have authority over a pool of cash gathered from affluent individuals, insurance companies, pension funds, and other institutional investors. Despite the fact that all of the partners share a portion of the fund, the VC firm selects how the investment will be invested, which is typically in enterprises deemed too risky for banks or capital markets. The venture capital firm is known as the general partner, while the other funders are known as limited partners.
Venture capitalists earn money on their investments through carried interest and management fees. The majority of venture capital firms retain approximately 20% of the income from their private equity funds, while the remainder is distributed to its limited partners. Additionally, general partners may take a 2% fee.
Each venture capital fund is unique, but their functions may be loosely divided into three categories: associate, principal, and partner. As the most junior position, associates are typically involved in analytical work, but they may also assist the firm in bringing in new prospects. Principals are more senior and involved in the day-to-day operations of the VC firm’s portfolio firms. Partners at the highest tier are primarily responsible for finding specific firms or market segments to invest in and authorising new investments or exits.
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This glossary post was last updated: 18th January, 2022 | 0 Views.