What are Venture Capital Funds?
“Venture capital funds are pooled investment funds that manage the money of investors who seek private equity stakes in startups and small- to medium-sized enterprises with strong growth potential.” These investments are generally characterized as very high-risk/high-return opportunities.
Venture capital (VC) is a type of equity financing that gives entrepreneurial or other small companies the ability to raise funding before they have begun operations or started earning revenues or profits. Venture capital funds are private equity investment vehicles that seek to invest in firms that have high-risk/high-return profiles, based on a company's size, assets, and stage of product development. MBA admission 2022 in Bangalore
Venture capital funds differ fundamentally from mutual funds and hedge funds in that they focus on a very specific type of early-stage investment. All firms that receive venture capital investments have high-growth potential, are risky, and have a long investment horizon. Venture capital funds take a more active role in their investments by providing guidance and often holding a board seat. VC funds, therefore, play an active and hands-on role in the management and operations of the companies in their portfolio. Best MBA college in Bangalore
Venture capital funds have portfolio returns that tend to resemble a barbell approach to investing. Many of these funds make small bets on a wide variety of young startups, believing that at least one will achieve high growth and reward the fund with a comparatively large payout at the end. This allows the fund to mitigate the risk that some investments will fold.
- Venture capital funds manage pooled investments in high-growth opportunities in startups and other early-stage firms.
- Hedge funds target high-growth firms that are also quite risky. As a result, these are only available to sophisticated investors that can handle losses, along with illiquidity and long investment horizons
- Venture capital funds are used as seed money or "venture capital" by new firms seeking accelerated growth, often in high-tech or emerging industries.
- Investors in a VC fund will earn a return when a portfolio company exits, either through an IPO, merger, or acquisition.
Operating a Venture Capital Fund
Venture capital investments are considered either seed capital, early-stage capital, or expansion-stage financing depending on the maturity of the business at the time of the investment. However, regardless of the investment stage, all venture capital funds operate in much the same way.
Like all pooled investment funds, venture capital funds must raise money from outside investors prior to making any investments of their own. A prospectus is given to potential investors of the fund who then commit money to that fund. All potential investors who make a commitment are called by the fund's operators and individual investment amounts are finalized.
From there, the venture capital fund seeks private equity investments that have the potential of generating large positive returns for its investors. This normally means the fund's manager or managers review hundreds of business plans in search of potentially high-growth companies. The fund managers make investment decisions based on the prospectus' mandates and the expectations of the fund's investors. After an investment is made, the fund charges an annual management fee, usually around 2% of assets under management (AUM), but some funds may not charge a fee except as a percentage of returns earned. The management fees help pay for the salaries and expenses of the general partner. Sometimes, fees for large funds may only be charged on invested capital or decline after a certain number of years. PGDM in Bangalore
Venture Capital Fund Returns
Investors of a venture capital fund make returns when a portfolio company exits, either in an IPO or a merger and acquisition. Two and twenty (or "2 and 20") is a common fee arrangement that is standard in venture capital and private equity. The "two" means 2% of AUM, and "twenty" refers to the standard performance or incentive fee of 20% of profits made by the fund above a certain predefined benchmark. If a profit is made off the exit, the fund also keeps a percentage of the profits—typically around 20%—in addition to the annual management fee.
Though the expected return varies based on industry and risk profile, venture capital funds typically aim for a gross internal rate of return around 30%.
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