How venture capital firms work (for entrepreneurs)
How Venture Capital Firms Work,
and Why You Should Care
What is a Venture Capital Firm, and how do
they fit into the financing ecosystem?
• Debt = loan you pay back
• Credit cards
• Commercial lender (bank)
• Convertible debt
• Venture debt
• Equity = sell part of company
• Angel investor
• Seed fund or Super Angel
• Corporate VC (Ex: Google
Ventures, Salesforce Ventures)
• Strategic investor (Companies that
invest without a fund/structure)
• VC, PE
Why you should care how your VC works
• VCs are part of the lifeblood of any startup or growth stage company
• They are among a small number of key stakeholders at the Board and Shareholder level who help
the company and help determine what happens to the company
Hiring, firing, compensating the CEO and other senior executives
Taking on debt, issuing more equity
Acquiring other companies
Selling the company or going public
• Good stakeholder management requires personal relationships and deep empathy
We practice that with managing people internally
We practice that with customers and partners
VCs are people, too!
• Deep empathy means understanding what makes someone tick
• Venture Capital firms…
Raise money from investors
Invest that money into companies in exchange for equity in those companies
Help guide and advise those companies
Receive money back when those companies sell or go public (or don’t if they
Return (most of) that money to their investors
Compare that to us – there’s a LOT in common
We (the Company) are
the VCs’ Customers!
Structure of a Venture Capital Fund
This is the firm that
employs the partners
These are legal
structures but not
These are the VCs’
Structure of a Venture Capital Firm
Partner Partner Partner
Who are LPs?
• Organizations with a lot of money to invest across a bunch of classes of assets
Government and corporate pension funds
Sovereign Wealth funds (governments)
High-net worth individuals funds of funds
• Asset classes vary and have different risk profiles and different return horizons and levels of liquidity
What a VC fundraising process is like
• A lot like a private company fundraising process
You have to kiss a lot of frogs…
You have to find a lead who sets the terms and usually anchors an advisory board
You keep soft-circling amounts until you get to your total desired fund size
You can have multiple closings
You need a good track record and a good lawyer
• Just like companies raise multiple rounds of financing, VCs raise multiple funds
Each fund can have different LPs, though they’re usually pretty consistent
Each fund can have different investment criteria and are increasingly doing so
The difference is that terms are usually the same (e.g., there’s no concept of “valuation”)
Track record matters are you get into more and more funds
How VCs invest money
• Investment Thesis (this is the firm’s Target Market)
This is what LPs are investing in the GPs as the “Management Team” to go pursue
Usually specific size, stage, sectors – and size of investment
E.g., Foundry Group themes
• Adhesive: AdTech related companies that provide the glue for the overall AdTech ecosystem. Sample companies include AdMeld, Beeswax, CrowdTap, Integrate,
• Distribution: Giant existing online markets can be completely disrupted by new distribution methods like Facebook, Twitter, Mobile, and User-Generated
Content. Sample companies include Betabrand, StockTwits, Sympoz, and Zynga.
• Glue: Computers love to talk to one another. The amount of “computer to computer interaction” is increasing at a dramatic rate. There’s a software layer that
“glues” this together. Sample companies include AppDirect, Cloudability, Gnip, Mapbox, mLab, Next Big Sound, Pantheon, and VictorOps.
• Human Computer Interaction: The way humans interact with computers 20 years from now will make the way we interact with them today look silly. Sample
companies include 3D Robotics, Fitbit, Harmonix, littleBits, Makerbot, Modular Robotics, Oblong, Occipital, and Orbotix.
• Marketplace: There are huge pools of remnant resources and new marketplaces are bringing those resources to the surface. Sample companies include Modria,
PivotDesk, Rover.com, and TeamSnap.
• Protocol: Many protocols – both formal and informal ones – support extensive software ecosystems. We’ve been investing in protocols like SMTP, RSS, XML, and
SMS for years and expect to continue doing this. Sample companies include Authentic8, FullContact, JumpCloud, Moz, Return Path, SendGrid, Spanning, Urban
Airship, and Yesware.
E.g., USV microtheme
• USV in 140 characters: invest in large networks of engaged users, differentiated by user experience, and defensible though network effects
• Different funds, different purposes
Main Fund, overlapping funds
Opportunity or Growth Fund
Fund of Funds
How VCs spend their time
• Principal activities
Prospecting (Sales Dev/Sales)
Managing the portfolio companies (Service)
• Firm day-to-day (Operating System)
Monday partner meetings
• Working with portfolio companies (Service Model)
As a director/shareholder
Additional support from the firm
• Indirect (referrals/support)
• Direct (consulting/operating partner)
How VCs make money
1. Management Fees – 2% of capital under management – this usually
pays the bills (office space, salaries, staff)
2. Reimbursement of Expenses – this is not supposed to be a profit
center, though some PE firms charge their companies expenses)
3. Carried Interest or Carry – this is where all the money is made
2 and 20
How Carry Works
• VC raises and invests $100
• Fund returns $300
• Over 10 years, fees consume $20 ($2x10)
• Gain is $180
• 20% = $36 to distribute to members of the firm
• 80% for LPs = $144, plus their original $100 back
• Politics and the “carried interest loophole”
• Is the 20% carry
investment income, therefore subject to preferential capital gains tax
earned income, subject to income tax treatment?
Typically a fund will invest $X in each company up front
Most top VCs will choose to take their “pro-rata share” of follow-on rounds
• Commitment Period
VCs can only use funds for a new investment for a limited time (~5 years)
This is why firms start new funds every 3-5 years- to stay active
• Investment Term
Funds also have an expiration (~10 years)
Extensions are possible
• Cross-fund investing: where a firm invests in the same company at different times from different funds
• Departing partners – getting voted off the island
Notes de l'éditeur
Management Company employs all of the people entrepreneur's work with at the firm and pays the day to day business expenses Limited Partnerships- this the fund money General Partnerships- legal entity role or owned by managing directors.
The arrangement between VC’s and their investors is a contract known as limited partnership agreement (LPA). VC’s have bosses also, their investors also known as LP’s.
Management fees- VC funds typically pay an annual management fee to the fund’s management company, as a form of salary and a way to cover organizational and fund expenses. Management fees are usually calculated on a percentage of the capital commitments of the fund(usually about 1.5-2.5%) Carried Interest or carry- Profit that VC’s get after returning capital to investors. Usually 20 or 30% of the profit. Reimbursement for Expenses- invested company pays for hotels, flights etc
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