Venture Capital
Venture capital is investment in early-stage companies that could grow many times over — minority stakes bought in rounds from seed to late stage, from funds raised from institutions, expecting most companies to fail and one or two to return the fund. It has financed fintech since the 2000s, and its model — power-law returns, staged rounds, preferred shares, a ten-year fund life — shapes every term sheet.
- Also known as
- Venture funding, VC, Venture fund, Venture investing
- Used at
- companies from pre-revenue to hundreds of millions of revenue, in rounds sized to eighteen to twenty-four months of milestones; fintech drew about a fifth of global venture funding in 2021 and a smaller share since
- Binding
- the fund's limited partnership agreement (ten-year life, an investment period, a fee and carry structure) and each round's documents — preferred shares with liquidation preferences, anti-dilution, pro-rata and consent rights
- Typical economics
- a 2% management fee and 20% carried interest; a fund that returns 3× is top-quartile; in a typical portfolio half the companies return less than the money invested, and the top two or three produce most of the fund's gains
- Typical stages
- pre-seed and seed ($0.5–5m), Series A ($8–20m), B ($20–60m), C and later ($50m+); each priced on the last round's post-money and the company's progress since
- Parties
- the general partner (the firm and its partners), the limited partners, the founders, and the later investors and acquirers who provide the exits
How venture capital works in practice
A firm raises a $300m fund from pensions, endowments and family offices, to be invested over five years and returned within ten. It invests in twenty-five companies at seed and Series A — $3–8m each, with reserves for follow-ons — takes board seats, and helps with hiring, customers and the next round. Then it waits. Fifteen of the companies fail or are sold for less than invested; seven return between one and three times; three grow into companies worth hundreds of millions or more, and their exits — sales or listings — return the fund. If one of the three is worth $2bn and the fund holds 12%, that single position returns $240m, most of the fund's gains; the carry on the fund's profit is where the partners' wealth comes from.
The model explains the terms. Preferred shares with a liquidation preference protect the fund's money in the middle outcomes; pro-rata rights let it concentrate in the winners; consent rights and board seats give it a say; the ten-year life means every investment is made with an exit in view. Founders who understand the model negotiate better: a fund needs its winners to be very large, so it will push for growth over profit and for a bigger round over a smaller one, and it will lose interest in a company that will "only" return 3×.
For fintech the model has a friction: a licence takes a year and capital, and a regulator's timetable does not follow a fund's — which is why fintech rounds are larger, earlier, and more often bridged.
Example
A $300m venture fund invests $5m at Series A in a payments fintech for 20%, with $5m reserved. The company raises a B ($20m at $80m pre) and a C ($40m at $200m pre); the fund takes its pro-rata at the B ($4m) and half at the C ($1m), holding 15.6% for $10m invested. Six years after the A the company sells for $600m; after the preference stack the fund receives $92m — 9.2×. Of the fund's twenty-five companies, this one and two others return $92m, $70m and $45m; the rest return $180m between them. Fund total: $387m on $300m committed after fees — a 1.3× net multiple, which is below the median; without this company, 1.0×. The fund's next raise depends on the story of the one company that worked.
Common mistakes
- Founders raising venture money for a business that will be worth $50m, which is a fine business and a bad venture investment. - Reading a term sheet's valuation without its preference, anti-dilution and consent terms. - Funds investing in fintech on software timetables and bridging the licence. - Over-reserving for follow-ons in every company rather than concentrating in the winners. - Treating a fund's ten-year life as a detail; it decides when the fund wants the company sold.