Bonjour, I’m back. We will begin with where we separated.
What is a VC Firm? How does a VC earn? Isn’t investing in startups risky?
Like startups raise money from a VC, VC’s also raise money from investors. And the firm where a VC works is called a VC firm. That’s it? Well no, this a way too simplified version.
So here is the actual version. Think of a mutual fund structure: The pool of money called the fund, people who manage the company called the asset management company and the investors who put their money to earn returns. And yes, also think about partnership. Does sleeping partner, active partner, minor partner come to your mind? If yes, great! If no, it’s absolutely fine.
Let’s get back to venture capital.
1. Investors
The investors who can invest in venture capital funds are accredited investors, which means HNIs, financial institutions and corporates. It’s a very risky investment, like hedge funds, hence retail investors are not allowed to invest. These investors are called limited partners(LPs) as they give their money but they don’t participate directly in selecting and investing in startups.
2. VC Firm
A VC firm is where a venture capitalist works. They are called general partners(GPs) as they manage the money of LPs, their money (Yes, a VC firm also has to put some money in the pool, usually a % of the total amount in the pool to keep their skin in the game) and the startups which they select and invest. For managing all this, what do they get? Well, here comes how does a VC earn.
VCs are compensated in two ways i.e.:
- Management Fee: As we all know, management fee is a certain percentage of the total money collected initially and is yearly, just like mutual fund managers fee. For example- The amount collected in the pool is 100 Rs and the management fee is decided as 2%, therefore the VC will take 2 Rs every year from the pool of money as management fees.
- Carried Interest: Carried interest is nothing but a portion(A percentage decided initially) of the net profit earned when a VC firm exits from a startup. Didn’t get it? Here’s an example: A VC firm invested Rs 100 in a startup ‘X’, carried interest 10%. After 5 years the value of that 100 Rs becomes 300 Rs. Therefore net profit is 300-100= 200 Rs. 10% of Rs 200, Rs 20 is what the VC will get as carried interest and then the remaining profit will be divided among other investors.
3. VC Fund
The money of the GPs and LPs goes into a fund, VC fund. A VC fund is usually a close-ended fund, that is, it is formed for a pre-decided period and the investors can’t withdraw their money during that period. We can call it as the life of the fund, the life of venture capital funds is usually 10 years (can vary). During these 10 years, a VC firm has to select startups, invest in them and exit (take the money back from the startups with returns or no returns)
- Purpose of the fund: As I said that a fund has a life, so there’s a purpose as well for that life. A VC firm decides the purpose of the fund meaning whether they will make investments focused or technology or consumer products, etc. This purpose depends upon the experience, expertise of the VCs and their expectations for the market. And yes, this purpose is shared with the investors when VCs go for fundraising.
Isn’t investing in startups risky? “100/10/1”
Yes, investing in startups is highly risky as some of the startups just have the idea which is not tested in the market, some of the ideas might be tested in the market but the path to profitability~ is unknown, some of the startups have the idea but research and development is required to be done for executing the idea, therefore the venture capitalists will try to understand the product-market fit~ but then if the startup becomes successful or not highly depends on the market conditions(Covid-19 couldn’t have been predicted!).
“100/10/1” – That’s why it’s often said that out of 100 startups, VCs will invest in 10 and only 1 out of the 10 would be a successful business. The remaining 9 would fail (Fail means they would either return the original investment amount or less than that), yes that is the reality of the startup ecosystem.
The obvious question which comes to your mind is ‘ Why to invest in something where the probability of success is just 10%(1/10)? ’ If I say the statement that higher the risk, higher the returns, I’m sure your reaction would be that high risk is fine but there’s something called as a calculated risk.
Well, let’s see the logic behind taking such a high risk.
- The one startup which turns out to be successful generates three times(3X), 10X, 20X or higher returns on the original investment. Yes, you read it right. Meaning if a VC invested Rs 100 in a startup ‘C’ and it turns out to be successful, the 100 Rs will become 300 Rs, 1000 Rs, 2000 Rs or even more(Yes, ~hockey stick growth!). So that one successful startup not only generates profit on that 100 Rs investment but also covers for the loss occurred due to the remaining 9 startups. Thus, I would say that this is also a calculated risk.
~path to profitability ~ product-market fit ~ hockey stick growth – Umm, let’s discuss this next time? Bonne journée!
Liked the Article you just read? Show us your support by clicking that like button and sharing it with your friends! Also don’t forget to leave your thoughts about the article in the comment section below.
You can become a part of our mailing list by clicking here
Im thankful for the blog. Great.
If you wish for to get a good deal from this post
then you have to apply these methods to your won webpage.
I go to see every day a few web sites and websites
to read content, however this web site presents feature based posts.
I really like your blog.. very nice colors & theme.
Did you create this website yourself or did you hire someone to do it for you?
Plz answer back as I’m looking to design my own blog and would like
to know where u got this from. many thanks
Hi, we would request you to get in touch with us. You can find our contact details on the contact-us page
As the admin of this web site is working, no doubt very rapidly it will
be well-known, due to its feature contents.
It is not my first time to pay a quick visit
this site, i am visiting this web site daily and
take pleasant facts from here daily.
I am sure this piece of writing has touched all the internet people, its really really good paragraph on building up new weblog.
I could not refrain from commenting. Exceptionally well written!
I need to to thank you for this great read!!
I definitely loved every little bit of it. I have got
you bookmarked to look at new things you http://apple.com/
Here is my web page – Jason
Hey Jason, Thank you so much. I’m glad you liked it! Unable to view your web page.