Whether you’re booking accommodations through VRBO, grilling up a plant-based burger from Impossible Foods or purchasing groceries through Instacart, you use services and products from venture capital-backed companies every day. Yet, people not working in the industry are unlikely to know much about this dynamic, active and evolving world. Even though the global capital markets are always changing, the fundamentals of venture capital remain the same. In this article, we break down the basics of venture capital and explain what you need to know. 

What is venture capital?

Venture capital is a form of financing where capital is invested into a company, usually a startup or small business, in exchange for equity in the company. It is also a major subset of a much larger, complex part of the financial landscape known as the private markets.  

What is a venture capital firm?

Venture capital firms are a type of investment firm that fund and mentor startups or other young, often tech-focused companies. Similar to private equity (PE) firms, VC firms use capital raised from limited partners to invest in promising private companies. Unlike PE firms, VC firms often take a minority stake—50% ownership or less—when they invest in companies. A firm's array of companies is called its portfolio, and the businesses themselves, portfolio companies. Examples of venture capital firms include:

Sequoia Capital

Headquartered in Menlo Park, CA, Sequoia Capital is a venture capital firm that invests in IT, mobile, internet, energy, media, retail sectors and more. The firm is an active investor in ghost kitchens, an emerging space tracked by PitchBook, and it has invested in companies Uber, Bird, DoorDash and 23andMe.

Andreessen Horowitz

Also based in Menlo Park, Andreessen Horowitz is a venture capital firm that has invested in companies like Lime, Airbnb, Instacart and Foursquare. In June 2021, the firm raised a $2.2 billion crypto fund, the largest vehicle of its kind and an escalation of VC's bid to back blockchain-focused startups.

DN Capital

London-based DN Capital in an early-stage VC firm that invests in software, fintech, mobile app, digital media, e-commerce companies and others. Founded in 2000, DN Capital founded such well-known startups as Shazam, Auto1 and Purplebricks.

 

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What is a venture capital fund?

To raise the money needed to invest in companies, venture capital firms open a venture fund and ask for commitments from limited partners. This process allows them to form a pool of money, which is then invested into promising private companies. The investments they make are typically in exchange for minority equity—which is a 50% or less stake in the company.

For example, BioGeneration Ventures II is a top Dutch VC fund. Based in Naarden, Netherlands and led by founder and manager Edward van Wezel, the fund makes investments into healthcare companies across seed, early- and late-stages. The fully invested fund has committed capital to Cristal Therapeutics and Synaffix—both drug discovery startups—among other companies.

What is a venture capitalist?

Investors working at a venture capital firm are called venture capitalists. They actively seek out investment opportunities for the firm as well as help raise capital for venture funds. In 2017, there were 4,589 active VC investors. To put that into perspective—since 2007, the number of investors in the industry has increased 163 percent.

Using the example in the previous section, BioGeneration Ventures' Edward van Wezel is a venture capitalist. 

What is the difference between angel investors and venture capitalists?

An angel investor is a wealthy individual who invests their own money into promising companies, whereas a venture capitalist raises and invests capital from limited partners. Mark Cuban and Lori Greiner, frequent investors on ABC’s Shark Tank, are examples of angel investors.

How does venture capital work?

As companies grow, they go through the different stages of venture capital. Additionally, firms or investors may focus specifically on certain stages—which impacts how they invest.

Seed stage

When a venture capitalist provides an early-stage company with a relatively small about of capital to be used for product development, market research or business plan development, it’s called a seed round. As its name suggests, a seed round is often the company’s first official round of funding. Seed round investors are typically given convertible notes, equity or preferred stock options in exchange for their investment. Sydney, Australia's Atelier—a private manufacturing network for beauty, health and wellness brands—raised $3 million of seed funding in November 2021. 

Early stage

The early stage of venture capital funding is intended for companies in the development phase. This stage of financing is usually larger in sum than the seed stage because new businesses need more capital to start operations once they have a viable product or service. Venture capital is invested in rounds, or series, designated by letters: Series A, Series B, Series C and so on. Founded in 2016, Austin's Yotta Energy raised $13 million of early stage VC, Series A funding in November 2021.

Late stage

The late stage of venture capital funding is for more mature companies that may or may not be profitable yet, but have proven growth and are generating revenue. Like the early stage, each round or series is designated by a letter. Series D, Series E and Series F are more common, but late-stage funding rounds can go up to a Series K. As an example, Boston's Snyk, a developer of security analysis tools, raised $605 million of late-stage VC, Series F funding in June 2021.

If a company a VC firm has invested in is successfully acquired or goes public, the firm makes a profit and distributes returns to the limited partners that invested in its fund. The firm could also make a profit by selling some of its shares to another investor in what’s called the secondary market.

What is corporate venture capital?

Within venture capital, there is a subset called corporate venture capital (CVC). A corporate venture capital firm makes investments on behalf of large companies that strategically invest in startups—often those operating within or adjacent to their core industry—to gain a competitive advantage or increase revenue. Unlike VC investments, CVC investments are made using corporate dollars, not through capital from limited partners. Examples of corporate venture capital firms include:

GV

As the corporate venture arm of Alphabet, Google’s parent company, GV seeks to invest in technology and media sectors. Founded in 2009 and based in Mountain View, CA, the firm has invested in companies like ClassPass, Lola.comBrandless and theSkimm

General Electric Ventures

As the corporate venture arm of General Electric, GE Ventures invests in healthcare and life sciences, energy and mobility and other sectors. Founded in 2013, the Boston-based firm has invested in companies like Carbon, Sarcos Robotics and Arterys

How do venture capital firms make money?

Venture capital firms make money by collecting management and performance fees. These can vary from fund to fund, but the typical fee structure follows the 2-and-20 rule:

Management fees

Calculated as a percentage of assets under management (AUM), typically around 2%. These fees are intended to cover daily expenses and overhead, and are incurred regularly.

Performance fees

Calculated as a percentage of the profits from investing, typically around 20%. These fees are intended to incentivize greater returns and are paid out to employees to reward their success.

What’s the difference between venture capital and private equity?

Both venture capital and private equity share the same goal: to increase the value of the business they invest in and then sell their equity stake (aka ownership) for a profit. However, they differ in four distinct ways:
 
  • The types of companies they invest in
  • The levels of capital they invest
  • The amount of equity they obtain
  • When they get involved in a company’s lifecycle

For a closer look at this topic, check out our blog post about the distinctions between PE and VC
 
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