What are Venture Capital Funds and How It Work?

Venture Capital or simply called VC in short form is a type of private equity. Venture Capital Funds manage the VC for investors looking to invest money in startups and early growth stage companies. It is termed as a high-risk high-reward investment type. These are managed funds by VC firms and investors.

Venture capital funds are actively managed funds through equity stakes in the funded company. Thus, these funds are offered by professional VC funding firms and professionals with the ability to influence the funded business. These funds provide substantial financial support to start up but require risking ownership controls with the investors.

What are Venture Capital Funds?

Venture capital funds are private or institutional investment funds that are used for funding startups and early growth stage companies. These funds are pooled investments from high-net-worth individuals and VC firms.

VC funds are risky investments as they are invested in startup companies without a proven performance record. Thus, these funds are termed as high-risk high-reward investments.

Startups and early-stage companies seek venture capital funds. These companies are risky investments and can only prove their worth in the long run. Thus, funding through a venture capital fund is a high-risk strategy.

Venture capital is a form of private equity. However, it is different in the sense that it focuses on startups and companies in the early growth stages. VC funds are often pooled investments from several individuals and VC firms.

Sources of Venture Capital Funds

A venture capital firm arranges the funds for investment. The venture capital firm also invests its own money but at a small scale. The larger chunk of investment comes from wealthy individuals or corporate investors. As this funding is risky, investors look for a higher return on investment typically around 30%.

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A venture capital firm plays the role of a middle-man between the investors and the funded business. Partners in a venture capital firm are responsible for arranging all the investment needs. They are also responsible for making key decisions regarding investments and appraisal of the funded entity.

Wealthy individuals and corporate firms can set up their own VC funds as well. For instance, Microsoft runs its own venture capital fund M12.

The Venture Capital Funding Process

Businesses seeking VC funding typically go through the following stages for investment approval.

  • The first stage is the idea generation and approaching a VC funding firm with a comprehensive business plan.
  • The second stage is the review of the business plan by the VC firm and a call on an initial meeting.
  • The next stage is an early introductory meeting between the two parties.
  • Then, the VC firm would conduct a thorough assessment of the applicant’s business plan and ability to execute it successfully.
  • An important stage before investment approval is the decision on terms and conditions such as the percentage of ownership, rate of return, and exit plan, etc.
  • The final stage is the approval and supply of funds to the applicant that becomes a partner now.

The plan of VC funding also includes the exit plan and distribution of returns to the investors. An exit plan can include different options such as an IPO, sale to other investors, mergers, and acquisition, etc.

Types of Venture Capital Funds

These funds can be categorized in two ways. Either it can be categorized by industry or by the funding stage of the business entity requiring funds. By a company’s expansion stages, VC funds are termed as:

  • Early-stage financing
  • Growth-stage financing and
  • Acquisition or Merger financing
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The venture capital funding process can happen in private funding series or rounds. These rounds can be categorized as:

  • Seed Money: It is the basic level funding at the idea and research stage of a business.
  • Series A: It is the startup funding stage for new companies at the marketing and production stages of products.
  • Series B: It is offered to companies at production but making losses in the early stages. It is used to enhance the operational capacity of the companies.
  • Series C: It is offered for companies looking at market share expansion.
  • Series D: This funding round can be used by companies for going public or mergers and acquisitions.

Advantages of Venture Capital Funds

Venture capital funds offer benefits to several parties involved in the process.

  • Startup and early-stage growth companies can acquire the necessary funding for growth.
  • Investors and VC firms receive a higher rate of return than other investments.
  • Startup companies also get strategic support along with financial support.
  • Businesses do not have a legal obligation to return investment, unlike debt financing.

Disadvantages of Venture Capital Funds

Venture capital funds can come with some limitations as well.

  • Investment in a new business is often risky and does not guarantee returns.
  • Businesses seeking VC funding have to sacrifice management control and ownership stakes.
  • Businesses need to repay the return on investment if successful that are higher than debt financing.
  • It is a lengthy, complex, and uncertain form of financing.

Conclusion

Venture capital funds are actively managed funds for private equity investments. These funds are offered to startups and early-stage businesses. These investments are risky and come with a high rate of return on investment. Funded companies have to share ownership and management stakes with the VC funding firm as well.

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