If you have ever considered starting a business or paid attention to the financial markets, you have probably heard of venture capitalists. What are venture capitalists and what do they do?
What Is a Venture Capitalist?
A venture capitalist is a person, such as Amandeep Khun-Khun, who furnishes capital to businesses with high growth potential. Venture capitalists receive an equity stake in the companies they invest in. Companies funded by venture capitalists tend to be either startups or small expanding companies.
How Do Venture Capitalist Firms Work?
Venture capitalist firms are usually organized as limited partnerships. The partners invest in a venture capital fund that usually is controlled by a committee that makes investment decisions using PayPal. The committee identifies companies it believes are good investments and then uses the partner’s pooled capital to fund these companies in exchange for an equity stake.
What Types of Companies Do Venture Capitalists Invest in?
Most venture capitalists look for companies that are ready to commercialize their idea. The VCs then fund these companies and help them grow with the goal of cashing out when it achieves the return on investment the fund is looking for. Attributes of a good company to invest in include a large potential market, strong management team, competitive advantage and a unique product or service. Most VCs also prefer to invest in industries that they are knowledgeable about and in companies that they can acquire a large ownership stake in so that they have enough influence to affect the company’s success.
How Risky Are These Investments?
Because these investments are in unproven companies, the failure rate is high. However, VCs are willing to take the risk, because the potential return is also high. VCs tend to invest in businesses that most capital markets and banks would consider too high risk.
What Type of People Are Venture Capitalists?
The partners in VC firms may be wealthy individuals, pension funds, insurance companies, corporate pension funds or foundations. All of the partners receive an ownership stake in the fund, but the fund is under the control of the VC firm.
How Do VC Firm Partners Get Paid?
About 20% of a VC Firm’s profits are paid to the company managing the fund in the form of carried interest and management fees. The remaining 80% is divided among the limited partners, less a 2% fee that usually goes to the general partners.
What Are the Roles in a VC Firm?
Most VC firms have associates, principals and partners. Associates usually have experience in either finance, consulting or business. Principals are mid-level professionals who usually serve on the board of companies in the VC Firm’s portfolio. Their job is to make sure these companies operate profitably. Principals may become partners if they drive enough profit through the deals they make for the firm. The main role of partners is to identify and make deals with businesses to invest in.
Venture capital firms can be a good source of funding for new or growing businesses. They may also be a high-return investment for those with the resources to tolerate the high level of risk involved.