A venture capitalist is a private equity investor who injects capital into startup companies or businesses that they deem to have a high potential for growth, in the same way as angel investors. Venture capitalists invest in businesses in exchange for an equity stake, making them a shareholder in the company. Venture capitalists are useful for companies who do not have access to equities markets.
How Are Venture Capitalists Formed?
Venture capitalists are formed as LPs (limited partnerships). This means that partners of the venture capital firm invest capital into the venture capitalists fund. After this, the committee of the fund makes informed decisions surrounding investments after identifying companies which they believe have excellent growth potential. In order to make an investment, the firms deploy the capital which has been invested by the partners in exchange for shares in the company receiving the investment.
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How Do VCs Decide Which Companies To Invest In?
Venture capitalists assess the companies’ potential for growth when deciding whether or not to invest in them. This means they make an assessment of whether or not the company has a strong management team alongside a sizeable potential market. In addition to this, venture capitalists will be assessing whether companies are offered specialised products or services which provide them with a significant advantage over their competitors.
Venture capitalists also often search for companies operating within familiar industries, to be able to offer guidance if they do invest. If they exchange capital for a large percentage of the company, they will be able to influence it during it’s growth period.
Why Do VCs Invest In Startup Companies?
Venture capitalists are willing to invest in up and coming companies if they can envision a large return on the investment they make. If the company becomes successful, the venture capitalist firm will profit from their original investment.
In spite of this, venture capitalists often invest in companies which are unproven, meaning investing money in them can be deemed as a risk. In this scenario, venture capitalist firms may lose the money which they have invested alongside their shares in the company, as it no longer exists.
Venture capitalist firms often have the opportunity to invest in startup companies because other lenders, such as banks, deem them too risky to make a large investment. Some startup companies, however, do not accept investments from venture capitalist firms because they do not want to relinquish any control over their business. Angel investors can also be preferable because if the company were to go bankrupt, the angel investors’ investment does not have to be repaid, whereas venture capitalists would have access to any liquidated assets.
How Are Venture Capitalist Firms Run?
Venture capitalist firms are run by the associate, principals and partners within the firm. Whilst the roles can vary slightly from firm to firm, this is the typical structure.
Associates usually have experience in the financial sector, whilst principals are considered to be professionals operating at mid-level within the firm. Principals are usually aiming to progress to become partners, however this is dependent on the returns they make through overseeing the investments.
Partners of the venture capitalist firm aim to identify businesses who they think would generate decent profits through investment, and can be responsible for representing the firm and sitting on the portfolio companies’ board. In a venture capitalist firm, the partners are the individuals who invest capital into the fund. These can be insurance companies, foundations, pension funds or wealthy individuals. The venture capitalist firm then had complete control over where the money is invested, although all investors are considered partners within the firm.
Typically, around 20% of the returns made go straight to the VC firm, whilst the remaining profit is split between the investors. Investments are made through management fees and additional interest.