Venture capitalists (VCs) are professionals who manage funds that invest money into startups. Unlike angel investors, venture capitalists are generally more process oriented and invest larger sums of money.
Venture capital firms launch venture capital funds from time to time. Venture capital funds raise capital from investors like high net worth individuals, family offices of wealthy individuals, endowments and foundations, pension funds, etc. Venture capital funds generally operate for a period of 8 to 12 years. Venture capital funds are generally regulated by the government.
Venture capital funds have 2 kinds of investors. The people who start and operate the fund are called ‘General Partners’ (GP). GPs invest some money of their own when they start a venture capital fund. The investors who do not manage the fund and only supply capital are called ‘Limited Partners’ (LP).
There are hundreds of venture capital firms worldwide. Countries like the USA, China and India have many of them. Many VCs are present in multiple countries. Some of the world famous venture capital firms are :
- Sequoia Capital
- Kleiner Perkins Caufield & Byers
- Andreesen Horowitz
The focus of every venture capitalist is to find the startups which can give a large return. A good return will be 25x or more return in 5 to 8 years. The reason VCs focus on high returns is that VCs generally lose money on 5 out of 10 startups they invest in. In 2-3 out of 10 they generally get the capital back or maximum double the capital invested. In only 1-2 startups out of 10, the good VCs get a large return. The venture capitalists focus on getting a few investments right out of the whole portfolio. This is very different from the traditional investment approach taken by other kinds of investors.
A question that generally comes to mind is when should a startup raise money from a venture capitalist. The answer is based on the lifecycle of the startup, the profitability of the startup and the willingness of founders to part with some control of the startup to investors.
VCs generally want to invest only if the startup has achieved product market fit. At product market fit the startup has a high demand for the product and there is high customer retention. VCs however sometimes do invest in other cases also based on the market, product potential and pedigree of founders. Thus if the product market fit has not been reached or is nowhere in sight the probability of being funded by VCs is quite low. I would advise founders to focus on achieving product market fit before going to meet VCs.
The other thing to consider is that VCs generally require a seat on the board of directors and also put restrictions on certain aspects of a startup’s operations. For example, it’s quite common for VCs to put restrictions related to the appointment of auditors, raising of future capital or selling founder’s equity without their approval, etc.
Thus if the business can generate near term cash flows many experts advise the startups to focus on getting funds from banks, etc. In case the profitability will take long run and cash flows would be low in the initial period and very high in the long run then VC funding is the only good option for large pools of capital.
Nearly all major technology companies have been funded by venture capitalists in the initial days. For example, Apple, Google, Amazon, Facebook, etc were also funded by VCs in the initial days. Thus venture capitalists may be a relatively small group of investors worldwide but venture capitalists have changed the face of the planet.
Suggested Reading :
- ‘Secrets of Sand Hill Road’ by Scott Kupor
- Mastering the VC Game: A Venture Capital Insider Reveals How to Get from Start-up to IPO on Your Terms
3 Steps To Startup Success