Venture Capitalist

Loading the player...

What is a 'Venture Capitalist'

A venture capitalist is an investor who either provides capital to startup ventures or supports small companies that wish to expand but do not have access to equities markets. Venture capitalists are willing to invest in such companies because they can earn a massive return on their investments if these companies are a success.

Venture capitalists also experience major losses when their picks fail, but these investors are typically wealthy enough that they can afford to take the risks associated with funding young, unproven companies that appear to have a great idea and a great management team.

BREAKING DOWN 'Venture Capitalist'

Well-known venture capitalists include Jim Breyer, an early Facebook (FB) investor, Peter Fenton, an investor in Twitter (TWTR), Peter Theil, the co-founder of PayPal (PYPL) and Facebook's first investor, Jeremy Levine, the largest investor in Pinterest, and Chris Sacca, early investor in Twitter and ride-share company Uber.

Venture capitalists look for a strong management team, a large potential market and a unique product or service with a strong competitive advantage. They also look for opportunities in industries that they are familiar with, and the chance to own a large percentage of the company so that they can influence its direction.

Brief History of Venture Capital in the U.S. 

Some of the first venture capital firms in the U.S. started in the mid to early 1900s, around the time of the second World War. Georges Doriot, a Frenchman who moved to the U.S. to get a business degree and ended up staying to teach at Harvard’s business school and work at an investment bank would go on to  found what would be the first publicly owned venture capital firm, American Research and Development Corporation, or ARDC. What made ARDC remarkable was that for the first time, it was a firm that raised money from sources other than exclusively wealthy family’s. For a long time in the U.S., wealthy family’s like the Rockefellers or Vanderbilts were the ones to fund start-ups or provide capital for growth. ARDC’s had millions in it’s account from educational institutions and insurers. 

Firms like Morgan, Holland Ventures, and Greylock Ventures were founded by ARDC alums, and still other firms like J.H. Whitney & Company popped up around the mid 20th century. Venture Capital began to resemble the industry it’s known as today after the Investment Act of 1958 was passed. The act made it so small business investment companies could be licensed by the Small Business Association that had been established five years earlier by then President Eisenhower. Those licenses “qualified private equity fund managers and provide(d)s them with access to low-cost, government-guaranteed capital to make investments in U.S. small businesses.”

Venture capital, by it's nature invests in new businesses with high potential for growth but also an amount of risk substantial enough to scare off banks. So it's not too surprising that Fairchild Semiconductor (FCS), one of the first and most successful semiconductor companies, was the first venture-capital backed startup, setting a pattern for venture capital's close relationship with emerging technologies in the Bay Area of San Francisco. Private equity firms in that region and time also set the standards of practiced used today, setting up limited partnerships to hold investments where professionals would act as general partners and those supplying the capital would serve as passive partners with more limited control. Numbers of independent venture capital firms increased throughout the 1960s and 1970s, prompting the founding of the National Venture Capital Association in the early 1970s.  

Dot-Com Bust

Venture capital firms began posting some of their first losses in the mid 1980s after the industry had become flush with competition from firms both in and outside the U.S. looking for the next Apple (AAPL) or Genentech. As IPO’s from VC backed companies were looking increasingly unremarkable, venture capital funding of companies slowed. It wasn’t until about mid 1990s that venture capital investments started back with any real vigor only to take a hit in the early 2000s when so many tech companies fell apart prompting venture capital investors to sell off what investments they had at a substantial loss. Since then, venture capital has made a substantial comeback, with $47 billion dollars invested into startups as of 2014.

Structure 

A Venture capital firm, along wealthy individuals, insurance companies, pension funds, foundations, and corporate pension funds among others pool money together into a fund to be controlled by a VC firm. All partners have part ownership over the fund, but it is the VC firm that controls where the fund is invested, usually into businesses or ventures that most banks or capital markets would consider too risky for investment. The Venture capital firm is the general partner, while the pension funds, insurance companies, etc. are limited partners.

Compensation

Payment is made to the venture capital fund managers in the form of management fees and carried interest. Depending on the firm, roughly 20% of the profits are paid to the company managing the private equity fund while the rest goes to the limited partners who invested into the fund. General partners are usually also due an additional 2% fee.

Positions Within a VC Firm

The general structure of the roles within Venture Capital firm vary from firm to firm, but they can be broken down to roughly three position. 

  • Associates usually come into VC firms with experience in either business consulting or finance, and sometimes a degree in business. They tend to more analytical work, analyzing business models, industry trends and subsections, while also working with companies in a firm’s portfolio. Those who work as ‘junior associate’ and can move to ‘senior associate’ after a consistent couple of years. 
  • Principal is a mid level professional, usually serving on the board of portfolio companies and in charge of making sure they’re operating without any big hiccups. They’re also in charge of identifying investment opportunities for the firm to invest in, and negotiating terms for both acquisition and exit.
  • Principals are on a ‘partner track’, and depending on the returns they can generate from the deals they make. Partners are primarily focused on identifying areas or specific businesses to invest in, approving deals whether they be investments or exits, occasionally sitting on the board of portfolio companies, and generally representing the firm. 
RELATED TERMS
  1. Adventure Capitalist

    1. Another word for "venture capitalist", or someone who invests ...
  2. Non-Banking Financial Company - ...

    Non-banking financial companies, or NBFCs, are financial institutions ...
  3. Diluted Founders

    A slang term often used by venture capitalists to describe the ...
  4. Private Purchase

    A situation in which an investor (either individual or institutional) ...
  5. Pre-Money Valuation

    A slang phrased that refers to the value of a company's stock ...
  6. Drive-By Deal

    Slang referring to a deal in which a venture capitalist invests ...
Related Articles
  1. Investing News

    Predicting the Biggest IPO of 2016

    Find out which tech startup company will bring life back to the struggling IPO market with the biggest initial public offering in 2016.
  2. Retirement

    Harry's Review: Is It Worth It?

    Find out if Harry's, the fast-growing, online purveyor of low-cost razor blades and shaving kits, is worth all of the hype in this review.
  3. Stock Analysis

    Uber: An IPO Candidate in 2016?

    Find out the reasons why massively successful Uber Technologies, Inc. may be a candidate for an initial public offering (IPO) in 2016.
  4. Entrepreneurship

    Does a Bigger Twitter Following Translate to More Revenue?

    Learn how small business owners benefit from large numbers of followers on Twitter, and how those large Twitter followings translate into more revenue.
  5. Professionals

    A Day in the Life of a Venture Capitalist

    Learn more about the job description of a venture capitalist and discover what a typical day in the life of this professional might look like.
  6. Entrepreneurship

    4 Things to Know About Your Company To Make a Successful Pitch to Investors

    Learn how to make a successful pitch to investors. Regardless of your industry, size or market, there are some questions all investors need to have answered.
  7. Stock Analysis

    Startup Analysis: How Much Is Dropbox Worth?

    Learn about the private company Dropbox and how it operates. Understand the company's current valuation, how it was derived, and if it deserves it.
  8. Stock Analysis

    Startup Analysis: How Much Is Lyft Worth?

    Learn about the private company Lyft and how it has become a successful rideshare company. Understand its most recent valuation and if it is deserved.
  9. Home & Auto

    The History Of Insurance

    The first written policy appeared in Hammurabi's Code. Find out how it evolved from there.
  10. Entrepreneurship

    How Venture Capitalists Make Investment Choices

    In order to increase your odds for receiving funding, here are some criteria considered by venture capitalists.
RELATED FAQS
  1. What are some of the disadvantages to taking venture capital?

    Learn how financing a business through venture capital can be a viable source of funding for small businesses but know caveats ... Read Answer >>
  2. What type of funding options are available to a private company?

    Understand how private companies can obtain financing for startup, growth or expansion projects, and learn how this differs ... Read Answer >>
  3. What steps are necessary for a business to secure equity financing?

    Understand the steps necessary for a small business to secure equity financing for working capital, financing expansion or ... Read Answer >>
  4. What is the best form of equity financing for a start-up company?

    Learn the equity financing options available to small business, and understand the best equity options for companies during ... Read Answer >>
  5. What are the different equity financing options available to companies in the United ...

    Learn what equity financing options are available to small, mid-sized and large companies within the United States and understand ... Read Answer >>
  6. How can I hedge my portfolio to protect from a decline in the Internet sector?

    Learn how investors hedge against declines in the Internet sector by diversifying their portfolios with non-cyclical and ... Read Answer >>
Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  3. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  4. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  6. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because ...
COMPANIES IN THIS ARTICLE
Trading Center