Failory - What Are Venture Capital Firms?

Hey — It's Nico.

In November, I'm publishing articles related to Venture Capital. This week, an introductory guide to VC: what is it, how does it work, what are the VC stages, pros & cons of raising VC, and more.

🙌 Welcome to the 462 founders who joined this week.

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What Is Venture Capital? Venture capital is a form of private equity financing that is typically invested in early-stage startups and small businesses that have long-term growth potential.

This capital often comes from venture capital firms, wealthy individual investors, and investment banks.

How Does Venture Capital Work?

1. You pitch your product idea to potential investors and convince them that it has a high potential for growth and profit.
2. The VC investors analyze your business idea and plan. If they think it has a high potential for success, they conduct further due diligence on your business model, product, co-founders, and everything else about your company.
3. If they are interested in investing, they will offer you a sum of money in exchange for a certain percentage of equity in your company.
4. You negotiate terms until you reach an agreement and receive the VC's investment.
5. After years, if your company goes public or is acquired, the venture capitalists sell their equity in exchange for massive returns.

What Are The Stages of Venture Capital?

• Seed: Very first round of VC funding. VC firms offer a small sum of money to help brand-new startups work on their business plans and create an MVP.
• Early Stage: It's divided into series A, B, and C. These are what startups use to spur on their initial growth and earn revenue after they have an MVP and some traction.
• Late Stage: It's divided into series D, series E, and series F. It's usually used to continue expanding operations once the startup is generating revenue.

What Are Venture Capital Funds? A venture capital fund is a type of private equity fund. Investors put their money into it for investing in early-stage companies. Each person who contributes to the fund is designated as a limited partner.

A single partner manages venture capital funds, called the general partner, and decides what companies to invest the fund in, based on specific criteria.

When a venture capital fund makes a return on an investment, the profit is split between all the limited partners, and the general partner earns a management fee in addition to a share of the profit.

How Do Venture Capital Firms Make Money? Two ways:

1. Management fees: Usually about 2% to 2.5% of the total funds they manage. They collect these every year, no matter the investment outcome. They are used to cover operation costs and other expenses.
2. Performance fees: These are calculated as a percentage of the profits from profitable investments. Venture capital firms usually collect 20% of the profits for funds that surpass predefined performance benchmarks.

What Are The Pros of VC Funding?

1. Your company grows much faster than possible if you were to continue bootstrapping it.
2. You get access to the VCs’ business expertise and guidance.
3. You get access to the VCs’ extensive network of investors, entrepreneurs, and business people.
4. You are not obligated to pay the investment back if your company fails.

What Are The Cons of VC Funding?

1. You will no longer have 100% control over your company.
2. Conflict of interests can arise if a VC firm that backs your company also invests in a competitors.

If you're interested in learning more about:

• the differences between VCs and angel investors
• how the process for raising VC works
• how to apply for VC funding

➡️ What Are Venture Capital Firms & How They Work​

This week I spent some time reading various startup-related resources and selected 3 of the best:

• ​Pieter Levels Makes Another Hit: After building 4 AI-related projects, Pieter Levels has made a new hit with AvatarAI, a tool that generates avatars using AI technology. He has been building and growing it publicly on Twitter.
• ​Biggest Mistakes on Pitch Deck Design: Josh Lu, from a16z, has created a Twitter thread collecting some common bad practices for designing pitch decks.
• ​How Much Are Founders Paying Themselves? Pilot, an accounting provider, has recently surveyed 500 startup founders on this question. This article shares the main takeaways.

Hope you enjoyed this week's article and curated resources ;)

Cheers,

Nico