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There is an opinion that without venture funds, the world today would be somewhat different: Google, Facebook, Netflix, Apple, Microsoft at one time attracted venture investments. Perhaps the mentioned companies could find money in other sources, but we will not abuse the conditional mood. Venture funds are one of the main sources of financing for startups these days. What is a venture fund, how does it differ from a venture company, what types of venture funds exist — read about all this in the first part of the article.
What is a venture capital fund in simple terms? A venture capital fund is an investment fund that invests in innovative companies and projects — including startups. The Fund manages investors' money by placing a premium on young companies that are growing rapidly and have a scaling strategy. Such investments generally offer high returns but also high risks. Thus, answer the question of what a venture capital fund means: it is a private investment instrument that finances high-risk but highly profitable companies.
Since the projects in which the venture fund invests have extremely high risk, the strategy for building a portfolio is to place small bets on a number of promising young startups.Thus, the chances of at least one of them taking off and paying off investments many times over are high.
Venture capital funds play a rather active role in the projects they have invested in: representatives of a venture firm often take a seat on the board of directors, take part in management, provide consulting and networking assistance.
A venture fund invests in exchange for equity in companies that are very likely to show significant growth.
Investment from venture capital companies is one of the most suitable options for financing young innovative companies that develop a unique product and need substantial sums to build it, market it and cover all associated costs.
Traditional sources of raising funds, such as credits, loans in this case either cannot fully cover the needs of such enterprises, or are inaccessible to them due to the fact that the owners of the company have nothing to provide the amount they want to get on the loan. This is why venture capital financing is widespread in fast-growing areas of the economy.
Most venture capital funds derive their income from two sources: the first is management fees and the second is interest from exits.
Management fee is the annual fee paid by investors in a venture capital fund to cover its operating costs. The size of the commission may fluctuate between 2 and 5 per cent, in some cases it may be higher.
Exit percentages are the income that the fund receives each time a successful sale of a portfolio company takes place.
Unlike business angels who invest their own money directly in a project, venture capital companies attract funds from a number of investors (these are wealthy individuals, including business angels, family funds, institutional investors) and form venture capital funds. In the Russian-speaking segment of the Internet the concept of «venture company» is only synonymous with venture capital funds. If we dig deeper, the concept of a venture capital company is broader — one venture capital company may have several venture capital funds. So a venture capital fund and a venture capital company are not the same thing.
As a rule, a venture company performs a dual role in the fund: it acts both as an investor and as a manager of a venture fund. As an investor, a venture company invests a certain percentage of its own money, this shows other investors that the company believes in the success of the fund and strives to do everything possible to achieve it.
As a fund manager, a venture company is responsible for identifying investment opportunities, innovative business models or technologies, as well as startups that will provide the fund with a high return on investment.
Venture funds often focus on industries (such as healthcare, finance, the Internet), market segment, stage of development, geography (only Russian startups, only startups whose product targets the American market), or a particular combination of these components. For example, the fund can invest only in US medical startups or early startups in a number of industries. As a rule, all this is determined by the experience of the fund team as well as market trends.
Here is how the classification of funds by investment stages looks like:
Pre-seed and Seed one. These funds specialize in closing pre-seed and seed rounds of startups, in other words, they invest in companies at early stages of development. These funds allow the founders to create a company, develop a product, and conduct market research. For example, the Russian venture fund FRII, or, as it is more correct to write, a venture company— is a seed fund.
Start-up capital funds. These funds enable companies to hire personnel, carry out necessary research to improve the product.
A Series Funds. Invest in enterprises that already have a finished product. The money raised allows to scale the project, increase sales, and cover marketing expenses.
Funds specializing in scaling. Invest in companies to help them enter new markets, develop and release new products.
Late-stage funds. Invested in companies that have been successful in commercial production and sales.
Mezzanine finance funds. Invest in companies that are preparing for an IPO.
In the second part of the article we will understand how the venture capital fund works, as well as become acquainted with the world’s largest venture capital funds.