Monday, February 11, 2008

In Brief: VC Business Model

VC firms:


Generally comprise a group of partners who do the following:
  • raise investment funds
  • source deals
  • perform due diligence
  • make investments
  • provide support to growing companies
  • realize the appreciation in investments

Business:
  • Earn high returns by investing in early stage companies

Sources of Investment capital:
  • Pension funds, corporations, banks, endowments (especially in the US) and wealthy individuals.

Fund structure:
  • Investment capital is held in a legally established fund:structured as a closed-ended fund, so no capital can be added at a later date with a defined life time, usually 10 years, after which the capital plus appreciation must be returned to investors managed and invested by the VC firm professionals providing investors with limited control and limited liability.

VC Fee structure:
2 levels of fees are paid to VCs by the fund:
  • Management fees:usually 2% - 2.5% of the total fund amount annually, which the VCs are allowed to take out of the fund to cover operating costs.
  • Share of the upside: 20% or more of the gain of the fund, after the capital is returned to the investors.
Investor expectations:
Expect an overall return of at least 25% or more, net of all fees, over the life of the fund. This roughly translates to a 50%+ rate of return (IRR) on any given investment.

Reference: National Entrepreneurship Network - http://www.nenonline.org

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