The rapidly expanding venture capital industry is providing the startup world with the much-needed impetus. While the VC industry has already become a potential driver for the US economy, the Southeast Asian countries have also started witnessing the gradual influence of venture capital on potential startups. The city-state of Singapore is already on its way to become the Silicon Valley of Southeast Asia owing to its fast developing VC industry. As an entrepreneur, if you are willing to raise venture capital for your startup, it would be a good idea to gather some information on how exactly the venture capitalists manage their investment funds and make profit.
Where Do The VC Investment Funds Come From?
I am sure you will be one of the happiest persons on earth after successfully raising your startup with venture capital. But then, how would you feel if you realize someday that you don’t really know where the VC investment funds actually come from? There must be someone to provide fund to the venture capitalists, right? So who they are?
Well, a major portion of the Dollars come from LPs, i.e. limited partner investors that mainly include large institutions like pension funds, charitable foundations, endowments, insurance firms and other wealthy individuals or families, corporations and a small percentage from HNIs as well. Typically, the contribution from the major partners of a venture capital firm is only 1 percent of the total investment fund.
How Do They Utilize The Fund?
The VCs usually pour their investors’ money in high-growth industries like Telecommunications, Software, Multimedia, E commerce and others. This is quite contrary to the myth that the VCs look only for good ideas. They, in fact, pick up one or a few growing industries and then look for innovative ideas in that sector.
Next to industry is the stage of development of the firm that they take into consideration. Venture capital firms prefer to avoid seed stage investments as the business at that stage is quite uncertain and the risk factor is very high. They try to meet their investors’ expectations by taking moderate risks and ensuring a huge ROI. Though there are VC firms that make seed-stage investments, the major interest is most at the growth stage (once commercialization begins).
To minimize the risk, the VCs usually invest in groups, i.e. two or more venture capitalists invest in a single startup to share the risk and gain returns from a moderate investments. This strategy not only decreases their workload but also gives them the opportunity to explore other investment opportunities in the market.
They expect a return of 25 percent to 35 percent on each year’s investment in the startup and the tenure usually ranges from 3 to 5 years. During this tenure, they provide the investee company with many additional services apart from capital, such as, offering guidance and knowledge sharing, contacts sharing, offering help in building business strategies and deciding exit-policies.
How Do They Choose Their Portfolio Companies?
The VCs usually choose their portfolio companies based on certain prerequisites like a unique business idea, an innovative business model, a sizable and scalable market, a great management team with excellent knowledge of management and finance, a strong pitch that drive their interest, business valuation papers and other important documents related to the origin of the business and most importantly a strong value proposition.
How Do They Protect Their Investments?
Typically, a VC firm prefers to become a part of the management team of the investee company and also takes part in critical board meetings. They desperately come forward to express their opinion on financial matters just to ensure that the fund they have invested is directed in the right direction so that each and every penny contributes to the overall ROI. Apart from this, they also prefer to invest in more than one startups to ensure that even if one deal fails, the other one manages to cover up the loss.
So that was just a small introduction to how exactly a venture capital firm operates. Hope the above information helps you in your overall research on the VC industry. If you have already kickstarted your venture capital raising campaign, you must see to it that you chase only the right investor, i.e. the one who is interested in the industry you are dealing with as I mentioned above. Also, remember to have all the prerequisites in the right place so that you don’t have to stumble at any point of time while in front of a potential investor.
Do share with us your capital raising experiences with us in the comment box given below.