Venture Capital

What is venture capital?

Google. Facebook. Yahoo. Netflix. LinkedIn. Snapchat. Instagram. They were all originally funded by venture capitalists. And the common theme was that two college dropouts built these companies starting in a garage in Silicon Valley, creating something-dot-com that would change the world. And the world is a mess. So it needs a lot of changing.

Venture capital comes in a few flavors. The earliest rounds are called “seed capital,” and usually mean that an original investor put in a few hundred grand...to a million or two. The money was invested at the very beginning of a company when it usually has no revenues, no product, no nothin’. Just a hope and a dream. And a big idea. And the idea can be huge. At one point, Yahoo’s original seed investment returned 10 thousand times its original capital. Regular seed level investors are called “angels,” and they are typically previously-successful founders or entrepreneurs who want to recycle precious high-risk capital back into the Silicon Valley ecosystem in that form. They know that 99% of their investments go bankrupt, but a few become lottery ticket winners that produce massive returns, and make up for the many losses.

Once a company has, say, a million bucks in revenue and has likely burned through the original seed money they raised, they would then seek to take in what’s called an A Round, i.e. a first level, full venture capital round, where the company raised 4 or 5 million dollars to then bring it to the next level of growth...in product use, revenue, or depth and power of patents or intellectual properties.

Later stages are tagged (cleverly) B, C, and D rounds. And when a company is in the tens of millions of revenue looking at a hundred million around the corner, they would raise what is called “growth capital,” as they are no longer a speculative venture, and they then appeal to a lower risk, lower reward group of investors.

So where does the venture capital money come from? The initial seed amounts are relatively tiny. A pocket of 50 million dollars might fund a hundred early startup companies for years, and in the scheme of all wealth, that $50 million is like lunch money.

A normal-sized venture capital fund might have half a dozen partners and another half dozen junior partners. It would raise money from what are called limited partners. The people responsible for investing the money diligently are the general partners. And for this pleasure, the general partners charge roughly a 2% per year management fee, and then also take a 20-30% “success fee,” or “carry,” if their fund pays back all of its initial capital and then has profits.

So, for a normal-sized venture capital fund, there might be 4 general partners. If they raise 400 million bucks, invest it well, and in, say, 8 years, have produced maybe a dozen IPOs and sold a half dozen other companies, so that the $400 million has turned into $2.4 billion, they would show a profit of 2 billion bucks. And if their carry was 25%, then the partners would split 500 million dollars among the four of them, in addition to the salaries they were taking along the way.

So yeah. Nice work if you can get it. And as an entrepreneur, if you’re looking to start any sort of major venture, you’ll need to attract some venture capital. Unless, you know...you and your buddy in the garage have a couple mil just lying around with nothing better to do.