What to Know about Venture Capital
Venture Capital (VC) firms collect money from a collection of wealthy individuals, insurance companies, educational endowments and pension funds.1 These assets are allocated over a portfolio of stocks, bonds, real estate, etc. Typically between 5% — 10% are assigned to “Alternative Investments.”
The alternative investments are the high-risk/high-reward class of assets and are what is available to fund startups.
VC firms are typically set up as limited partnerships with two types; limited and general partners. Limited partners provide the funding in the form of a Capital Commitment, or obligation to pay when called upon. It is the responsibility of the general partners to put together deals that are attractive to their counterpart, in exchange for a percentage of profit.
VC firms knowingly make high-risk investments. The funding they provide is in exchange for equity in the company, and like all things when dealing in risk — the higher the risk, the more expensive it is. Your risk as a startup will be determined by the information and confidence you present. Ownership required by the VC firm can range between 15% — 25%.
The funds raised in a VC round for a tech startup serve one major purpose — scaling.
VC firms evaluate businesses that have a proven track record and product. Candidates must be able to present evidence to the market and sales potential and are interested in either growing up or out (geographically or for enterprise). This limits who this applies to primarily, but not exclusively, to tech businesses.
In order to be accepted by a firm, the numbers must work. VC firms work in the millions and billions, and will expect a model that has the capacity provide a large exit. While most VC recipients do not reach the numbers required for acceptance, confidence in the company’s potential is expected.
Of the millions of companies created every year, just a few thousand get VC funding. Nearly every tech company you recognize has been funded by VCs, including: Apple, Amazon, Google, Facebook, eBay and PayPal.
1 The Nuts and Bolts of Business Plans – MIT Course 15.S21. By Joe Hadzima (nutsandbolts.mit.edu)