Venture Capital Funds are usually high-risk investments targeting high returns. The funds are invested in businesses that are considered too risky for the standard capital market and bank loans. Mostly businesses that are in their formative years when capital is required for growth or simply to start-up. Venture capital fund is usually invested in privately owned companies in innovative technologies like the Information Technology, Biotechnology and funds are invested in to the business rather than lending money.
Venture capital firm can fund anywhere from $10 million to $350 million and function for a specific time period of 7-10 years. Venture capital funds usually come from state and corporate pension funds, insurance, private endowments, and individual investors known as angel investors.
Venture capital fund structure is usually a limited liability partnership or limited liability company. People who invest money in to the fund are Limited Partners (LP's) and people who utilize the funds for business growth are General Partners (GP's). Generally the limited partner's contributed share is 99% whereas the general partner's share is 1%. As the profits come in on the invested capital, the committed capital is shared among the partners in the same percentage. The general partners receive 20 % of the net capital gain and the limited partners get the lion's share of the gain that is 80%. Venture capital fund also receives an annual management fee, which comes to 2.5%of the committed capital.
Venture capital fund works through three stages that approximate to about 10 years. Since the venture capitalists do not lend money but take an active part in the invested enterprise.
Fundraising is the first stage where the general partners of a venture fund engage in acquiring capital from its limited partners. Fundraising process takes about 6 months to a year.
Due diligence is the second stage that takes up to 3-6 years. Firstly potential business are identified for investment. In venture capital parlance due diligence process is called sourcing. When a business is sourced it means it has been bought to the venture capital firm's notice. After a potential enterprise is sourced, thorough research begins into the business's prospects, its market, its viability and its profit creating ability. This is called due diligence. Once a business comes through in due diligence, money is invested in the business and it becomes a 'portfolio company'.
Business growth is the third stage and lasts till the closing of the fund. This stage consolidates a business and helps it grow. The venture capital firm and the portfolio company combine to pool in their resources to make the company grow. Venture capital firm acquires an equity partnership in the portfolio company through a combination of stocks, convertible securities and warrants. Venture capital firm also elects its own representative to the company's board apart from financing the venture. This member looks after the firm's interests and often takes a proactive part in management decisions.
Closing is the final stage in the life of a venture fund. By the time the Portfolio Company has established itself the venture fund completes ten years. The venture capital liquidates all its shares in the company either by Initial Public Offering (IPO) or selling the company to a third party. By the end of this stage the venture capital gets the maximum return on its investment.
America's advances in technology has mainly fueled the venture capital funding market. To give credit correctly General George Doriot is considered to be the founder of venture capital funding in the U.S. In 1946 he established the American Research and Development (ARD) Corporation which funded the venture Digital Equipment Corporation. When this company became an IPO it netted ARD 101% in returns on investment. The first venture funded start-up business is the Fairchild Semiconductor Funded in 1956 by Venrock Associates.
Breakthroughs in computers and its associated technology in 1960-1970 resulted in venture capitalists funding technology-based companies. After a slump in 1980's the venture firms bounced back in the 1990's with the IT enterprises in the Silicon Valley. The ebay's purchase of Skype, the News Corporation's purchase of Myspace.com, Google.com and others have rocketed venture capital on to its highest platform yet. By 2006 $6.6 billion had been invested in 797 companies across America by the venture capitalists.