How do venture capital firms make money by investing in startups?
The venture capital fund itself makes money…
…by investing early in a startup company’s life, when success is not at all assured. In exchange for investing capital to help the company grow, the fund receives an ownership interest in the company. Because in the early days a company will not be worth very much, the fund’s ownership interest will be worth exactly what it paid. But as the company grows and becomes more valuable, the value of the fund’s corresponding percentage grows as well.
Ultimately, the company will be either sold to a larger company (at a higher price) or begins to sell shares through the public stock market (going public with an IPO). In either case, the venture capital fund sells the shares that it owns, for more money than it originally paid for them.
The general partners of a venture capital fund make money…
…by raising the bulk of the capital that the fund’s investable capital from “Limited Partners”, usually institutions such as university endowments, insurance companies, and pension funds. This is the money that is invested in the startups. When the fund itself makes money from a successful exit (as above), the first thing that happens is that the original investments are returned to the Limited Partners, and then after that, 80% of profits are paid to the LPs, but 20% of the profits are retained by the General Partners (known as “GPs” who run the fund.
In addition, every year, the managers of the fund (the GPs), are entitled to pay themselves 2–3% of the total amount of the fund to pay their expenses and salaries. (In many, if not most, cases, this management fee can significantly exceed the “earned” amount from the “carried interest”).
*original post can be found on Quora @ http://www.quora.com/David-S-Rose/answers *
Written by David S. Rose
You might also be interested in
Canada has not tapped its female angel investor potential – yet.
The female angel investor conversation has been discussed inside and out. From TechCrunch, BetaKit to the Financial Post, there have been more than a few arguments made about the lack of female representation in Canada’s early-stage investment community and the benefits of tapping into this financial resource.
One of the most common questions we get is: What are the biggest challenges and rewards of angel investing? High net worth individuals become angel investors for a number of reasons, but the opportunity to work with entrepreneurs and provide guidance to founders is typically high on the list. In this video, angel investor Chenoa Farnsworth explains why, interestingly, both the biggest
Entrepreneurs seem genuinely surprised to find that investors in Peoria or Little Rock are not willing to invest in startup companies at Silicon Valley prices. After all, they just read in TechCrunch that investors funded a company similar to theirs at an $8 million pre-money valuation!
The valuation of startup companies shouldn’t be impacted by location, should they? Guess again!
The first question you need to ask is “What country are you in?” and the second is “Are you an Accredited Investor by that country’s standards?”
If we’re talking about the US and you are NOT at the Accredited level ($1 million in investable assets, or $200,000 annual income), then for the moment you are actually not allowed to invest in privately held startups
First, it’s important to understand that the four platforms you list fall into two very distinct groups.
Kickstarter and IndieGoGo are project-based crowdfunding platforms through which anyone can contribute money, either as a donation or with the promise that they will receive a tangible ‘reward’ of some kind if the project is successful.
Gust and AngelList are equity-based platforms, used by Accredited Investors to facilitate the investment of money for an ownership interest in