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Venture Capital Firms and Funds

By August 10, 2017Seed Banks
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Venture Capitalists

What is a venture capitalist?

A venture capitalist is an individual who makes investments in businesses before the firm goes public. In addition to bringing money to the business venture, capitalists usually bring managerial and business-specific talent to the business, and will take assume equity and generally a board seat in return for investment in the business.

What is a venture capital fund?

A venture capital fund is a pool of financial capital, managed by a firm which invests in businesses often considered too risky for a bank to lend to or for an average investor to invest in.

What is a pool fund and why is it used?

A pool fund in VC terms is a fund that, much like a mutual fund, invests its money in several different firms rather than investing all of its money in only one firm. This format reduces risk to investors and creates a greater average upside return.

In what type of businesses to VC firm typically invest?

Although technology firms have been highly favored by many venture capitalists, VC businesses often consider all types of businesses in which they can acquire some expertise– as long as the firm’s investment requirements are met. These details were discussed in another article.

At what stage of a business do the VC firms expect to earn a profit?

Given a choice, every VC firm would like to generate profits as soon as money is invested but, realistically, that rarely happens. Most VC firms expect to show a profit within a couple of years and rarely expect to exit an investment before three years. They do expect to exit before the seven year mark.

What type of returns do VC firms look for?

VC firms look for a minimum 40% annual rate of return from their investment. Realize they expect a return “of” and a return “on” capital invested.

In what type of businesses do VC firms want to invest?

VC firms want to invest in businesses with novel technologies which have the ability to revolutionize the industries in which they invest. This can range from food production to technology all the way to manufacturing. VC firms want returns. The category of investment from which these firms derive their return is not as important as would be expected.

Some VC firms invest in:

* Start-up companies or new ideas, and/or
* Local or regional companies, preferring not to venture too far from territory they understand
* Underperforming companies, and/or
* Specific industries such as health care or manufacturing

Examples of businesses that can revolutionize an industry:

* Google – offers an innovative searching capability
* McDonalds – Standardized fast food when there were few fast food chains.
* Wal-Mart – Lower price retailer offering almost every item an average family needs. Wal-mart started in small communities, established a large foothold throughout the US and eventually moved into larger markets when prices were low enough and retailing skills were high enough.
* Automobiles operating on hydrogen, derived from water, rather than petroleum.

Venture Capital Firm Structure

A venture capital firm is typically formed as a partnership with a general partner(s) (GP(s)) and limited partners (LP(s)).

* General partners manage the firm, control investor monies and the businesses in which they invest. GPs may incur unlimited financial risk if a business fails and can be liable for some corporate debts.
* Limited partners provide money to the VC firm to be invested and their risk is limited to the amount of money they place with the firm to be invested.

Many VC firms legally structure their firms as LLCs (limited liability corporations) in efforts to minimize risk to the partners.

Where go VC firms get investment money?

VC firms receive money from their investments from accredited investors, high net worth individuals, pension funds, insurance companies, university endowments, and- on occasion, from hedge funds.

What is an accredited investor?

In 1933, the Securities and Exchange Commission (SEC) had a change in administration and President Franklin Delano Roosevelt wanted safeguards put into place inhibiting stock manipulation and stock fraud which had occurred throughout the 1920s.

The SEC mandated that some investments required accredited investors which, in general, are individuals who have some expertise in an area and, if an individual, a net worth of at least $ 1 million and an annual salary of $ 200,000 for the past two years or $ 300,000 in the past two years if including a spouse (2012). The accredited investors must expect to earn the same income or more the following year.

There are some types of investments in which the SEC will only allow accredited investors to invest, including very high risk investments such as venture capital, limited partnerships, private placements (both stock and/or real estate related), hedge funds, and seed money investments.

Accredited investors generally include high net worth individuals, insurance company investment funds, banks, some types of endowments, and corporations.

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