What is Venture Capital?

What is Venture Capital?

• Venture capitalists facilitate investment into early-stage, private startup companies, often at substantial risk and in environments of high subjectivity and high ambiguity
• In the last 30 years venture capital has delivered 19% annual return at a lower volatility than many stock market indices
• Venture capital is always nearly a long-term investment - building a company takes a long time, so it’s not an asset class for short-termism. A clear example of this is Benchmarks investment into Uber in 2011, turning $11m into $6.8bn in just eight years

What is the setup of a VC fund?

The VC fund consists of the following:

1. Venture fund - This is the vehicle used to make investments into new companies, and it is made up of a number of different stakeholders
2. Limited Partners (LPs) are the institutional investors who invest their money into a fund with the expectation of return upon their investment. These are typically large public and corporate pension funds, insurance companies, fund of funds, sovereign wealth funds, etc.
3. General Partners (GPs), they are responsible for the day-to-day management of the fund, marketing of the fund, and they make decisions as to the investments that the fund makes

How do the General Partners of VCs make money?

A key challenge for a fund structure is to align the interests of the LPs and GPs, so most venture capital firms are rewarded through the ‘two-and-twenty’ model.

What is the two-and-twenty model?

• The ‘two’ refers to the management fees the General Partners receive from LPs for fixed remuneration, operating expenses, office space, the hiring of staff to source and manage investments, and other day-to-day costs. This is typically around 2% of the fund each year
• The ‘twenty’ in the model refers to carried interest. Carry is the percentage the GPs receive from the profit returned to investors, which typically varies around a standard 20%

How do firms split the carried interest between individuals?

1. Some funds decide to split carry based upon individual performance
2. Others might share equally amongst everybody
3. Or something halfway between the two