Venture Capital Firms

Structure

A venture firm is not the same thing as its funds. The firm is the management company, owned by its partners. Each fund is a separate limited partnership with its own investors, term and investments. The firm's general partner entity manages the fund and makes the decisions; limited partners supply nearly all the capital and have no role in picking companies.

A fund moves through a standard life.

• Formation: the firm sets strategy and terms and collects commitments from investors in one or more closings.
• Investment period: usually the first several years, when the firm calls capital and makes initial and follow-on investments.
• Harvest: the later years, when the firm supports companies, sells positions and distributes cash.
• Wind-down: final sales, a last distribution and dissolution, sometimes after extensions.

The economics have two layers. A management fee, set in the partnership agreement, pays for the firm's operation. Carried interest pays the partners a share of profits after investors receive their capital back and, usually, a preferred return. Management Fee and Carried Interest explain each layer in detail.

Worked Example

Consider a hypothetical venture firm managing a $100,000,000 fund. Using the fee schedule in the management fee example, total fees over the life of the fund are $14,500,000, so $85,500,000 is available to invest. Assume 40 percent of that, $34,200,000, is reserved for follow-on rounds and 60 percent, $51,300,000, goes to initial checks. If the firm plans 25 initial investments, each initial check averages $51,300,000 divided by 25, or $2,052,000.

That arithmetic determines what the firm can do. A firm with a $2,000,000 average first check and a $34,200,000 reserve can lead or co-lead seed rounds and keep investing in the best companies through Series A. It cannot lead a $40,000,000 growth round without a much larger fund. When founders ask whether a firm fits, they are asking whether its fund size, check size and reserves match the company's needs. A fund that is too small may be unable to follow its winners, and one that is too large may need larger outcomes than a young company can deliver, a point developed in early-stage venture capital.

Types of Venture Capital Firms

Firms differ along a few lines, and the differences matter more than brand.

• Stage: pre-seed and seed specialists, multi-stage firms and growth investors. See startup funding stages.
• Sector: software, life sciences, climate and others. A sector specialist brings diligence skill and networks.
• Origin: independent firms, corporate venture arms, university or government-linked programs and firms led by former operators, as described in operator-led venture capital.
• Regulatory status: many venture advisers rely on the venture capital fund exemption in 17 CFR 275.203(l)-1 and report to the SEC as exempt reporting advisers, which means their Form ADV filings are public on the SEC's Investment Adviser Public Disclosure site.

A founder or limited partner can use that public site to confirm a firm's legal name, affiliated funds, ownership and disciplinary history before a meeting. A firm that cannot be found, or whose filings contradict its marketing, deserves questions.

What It Means for a Limited Partner

A limited partner chooses a firm, not a fund, because the partners and process carry from one fund to the next. The relevant questions are whether the partners who produced the record are still there, whether fund size has grown faster than the team, how decisions are made and whether the firm's economics reward good outcomes for investors or only growth in assets. Fund size matters: a larger fund needs larger exits, and a firm that doubles its fund while keeping the same strategy may be stretching it. Alignment matters too, as GP Commitment shows, and so does protection if a key partner leaves, described in Key Person Provision. A written review of firm operations, using the approach in Operational Due Diligence in Private Equity, completes the picture. Software founders can apply the same fit tests described in best VC firms for SaaS startups.

In Life Sciences and Healthcare

Life sciences firms often combine investors with scientific, clinical or regulatory training and operators who have built companies. Founders should ask which partners have taken a product through approval or clearance, how many company boards each partner sits on and whether the firm has the reserves to follow a company through multiple financings. Limited partners should ask the same questions, because a life sciences firm without the depth to judge clinical evidence is likely to rely on others who may be less accountable.

Frequently Asked Questions

How do venture capital firms make money?

They earn a management fee, paid by their funds to cover operations, and carried interest, a share of profits paid after investors receive their capital back and usually a preferred return. The fee is predictable and the carried interest depends on results, so partners are paid most when investors do well.

What is the difference between a venture firm and a venture fund?

The firm is the management company and its partners. A fund is a separate partnership that holds investor commitments and investments for a fixed life. One firm often manages several funds in sequence, each with its own investors, term and portfolio. Performance is reported fund by fund.

How can a founder check a venture firm's background?

Search the SEC's Investment Adviser Public Disclosure site for the firm's Form ADV, which lists ownership and affiliated funds. Then speak with founders in the portfolio, including those whose companies struggled, and read the criteria in top venture capital firms to compare fit.

Related Reference

Venture firms sit alongside the later-stage investors covered under growth equity. Related entries: Management Fee, Carried Interest and GP Commitment.