What is Venture Capital?
Venture capital is a form of private equity and a type of financing that investors provide to startups or early-stage companies and small businesses that are believed to have long terms of growth potential. Venture capital generally comes from well-off investors, investment banks, and any other financial institutions. Venture capital, for the most part, is structured as an investment fund that the source of capital comes from private and public capital such as pension funds, retirement accounts, hedge funds, and other long term investments, typically allocated to small companies with exceptional growth potential, or to companies that have grown quickly and appear poised to continue to expand.
Though it can be risky for investors who put up funds, the potential for above-average returns is an attractive payoff. For new companies or ventures that have a limited operating history (under two years), venture capital funding is increasingly becoming a popular – even essential – source for raising capital, especially if they lack access to capital markets, bank loans, or other debt instruments. The main downside is that the investors usually get equity in the company, and, thus, a say in company decisions.
In a venture capital deal, large ownership chunks of a company are created and sold to a few investors through independent LP or SPV that are established by venture capital firms. Sometimes these partnerships consist of a pool of several similar companies. One important difference between venture capital and other private equity deals, however, is that venture capital tends to focus on emerging companies seeking substantial funds, between $1M-$5M for the first time, much larger than Angel Investors, between $250-$1M while PE firms tend to fund event larger, typically $5M plus into more established companies that are seeking an equity infusion or a chance for company founders to transfer some of their ownership stakes. A typical VC charged the investors what called the 2/20. This means that they receive a 2% management fee of the total capital under management in addition to sharing 20% of the upside performance of the fund after the investors repaid their initial investment. The entry-level into a VC fund is typical $500K and up.