The venture capital industry is the driving force behind technology companies that are changing the world. Many new investors are now rushing into the asset class to get exposure to the companies producing unprecedented levels of growth and returns. Find out what a venture capital fund is and how it really works.
The Venture Capital Fund
A Venture Capital fund is a pooled investment fund by which the Venture Firm allocates capital to startups in exchange for equity. Typically, VCs are focused on technology startups with characteristics that enable them to scale and grow quickly. These companies are regarded as highly risky, however have the chance delivering high returns. Note that a VC firm may have more than one fund at any given time with varying areas of focus and strategy.
The Stakeholders
It’s important to note the distinction between a venture fund and a venture firm. While a venture fund is an entity upon which investments are made into startups, the venture firm is the overarching entity that encapsulates all of the funds and management company.
- Limited Partner
Limited Partners (LPs), are the investors in a venture fund and contribute most of the capital. They invest directly into the fund and receive earnings once / if the fund produces returns. Typically, once returns are actualized, LPs receive their entire investment into the fund after which the remainder of the profits is split 80:20 between the LPs and GPs respectively, depending on the fund.
LPs are often endowments, pension funds, institutional investors, family offices and HNWIs.
- Managing Partners
Managing Partners are in charge of the operations of the Venture Firm, and the particular fund’s long-term strategy. They make investment decisions and distribute the capital they’ve raised from LPs and typically put up 1-2% of the fund’s capital.
Fund managers are often VCs / investors with experience, entrepreneurs and domain experts.
To learn more on the other roles in venture capital click here.
The Structure
To invest in a startup in venture capital, several entities must be formed. The venture firm is a construct of all of these entities combined. These structures can become very complex, below is a representation of the most popular structure.
- The Limited Partnership
Investors into the fund will put money into a limited partnership entity, which will then distribute capital to portfolio companies. This entity is where the capital is held and distributed.
- General Partnership
The General Partnership is made up of the partners in the fund and this entity receives carried interest.
- Management Company
The management company is used to manage the fund’s expenses such as salaries and rent. Managing Partners are owners of the management company and thus control the venture firm.