Venture Capital Explained

Capital at risk. Nothing in this article constitutes investment advice.

Venture capital funds are the driving force behind the world's most innovative and revolutionary companies. We're here to help you explore the exciting world of venture capital, where individuals, institutional investors, and forward-thinking funds come together to shape the future. Venture capital encompasses a unique form of funding that pools resources from investors to support early-stage startups. The focus lies on companies exhibiting substantial long-term growth potential, seeking capital infusion to propel their development and expansion. Venture funds often concentrate on specific industry sectors, business models, or geographic regions where they can leverage the expertise and experience of their general partners. Given the inherently higher risks associated with startup ventures, many of which explore uncharted territories, develop novel products, or scale their operations to reach wider audiences, venture funds play a pivotal role in helping their startups succeed. They not only provide financing but also bring valuable expertise to the table via their networks. The potential rewards for success in this asset class are notably higher than in others, making it attractive for investors to participate in the challenge of building new businesses that continue to shape our everyday lives.

Navigating the Risks and Rewards

Considering the unpredictable nature of early-stage startups, venture funds manage risks by making relatively modest investments in a diverse portfolio of companies, typically 15-40 companies per fund. Should any of these ventures succeed the return prospects are substantial. Moreover, venture fund managers take on an active strategic role in their investments, working closely with entrepreneurs to optimize strategies, enhance capital efficiency, and expedite market entry. As such, VC backed startups often have a much higher chance (4x higher according to Beauhurst) of success compared to those that rely on crowdfunding. Typically, venture funds seek exits through initial public offerings (IPOs) or acquisitions by larger public or private companies. Some may also sell their interests to entities specialized in acquiring such assets, private equity firms being an example. This approach allows venture firms to return capital to investors within the fund's expected lifetime.

Fueling Early-Stage Growth

Venture capital funds fill a critical financing gap for high-risk companies in their early stages of growth, as they often lack access to public equity markets and are deemed too risky for traditional bank loans. Moreover, venture fund managers not only provide essential financing but also lend seasoned expertise to exceptional entrepreneurs, thereby enhancing their credibility and fostering strong financing relationships. Ventures advance through various stages of financing, starting with the Seed stage for the earliest startups, with investments typically amounting to $3 million or less. Subsequent financing rounds follow, designated as Series A, B, C, and so forth, each aiming to further develop and scale the company's products or services. Depending on their strategy, venture capital firms may invest in specific financing stages or continue to support companies in later stages.

Structure of Venture Capital Funds

Now that we've covered how VC manage risks and support early stage companies, let's cover the typical structure of venture capital funds. Generally this involves limited partnerships managed by a general partner (GP) and financed by investors who serve as limited partners (LPs). This structure offers pass-through tax benefits, making it preferable for venture funds. The general partner, often a dedicated venture capital firm with substantial experience in financing startups, takes full legal responsibility for managing the fund's operations and investments. GPs are compensated through fees and/or a share of the profits known as carried interest, aligning their interests with those of the investors. LPs, on the other hand, represent the fund's investors, which can range from high-net-worth individuals to institutional investors like pension funds, insurance companies, or family offices (and now YOU!). They provide capital as passive investors, limiting their liability to their investment while the GP handles the fund's management and legal responsibilities. Successful venture capital firms with a proven track record go on to raise successive funds to invest in more and more startups. Each fund is for the most part distinct, so if VC fund 1 bought into startup X and you investing in VC fund 3, you are unlikely to get exposure to X as you are essentially invested in a different limited partnership – even though it's the same venture capital firm.

The Venture Capital Fund Life Cycle

So now that we've covered how they're structured, lets now look at the lifecycle of a fund and the roles managers play throughout. Venture capital funds typically undergo four key stages in their life cycle:

Stage 1: Fundraising

During this phase, the VC fund establishes its partnership structure, finalises its strategy and limited partnership agreement, and seeks investors. The general partner concurrently conducts research, identifies potential targets, and assembles the team. The duration of this process varies, often taking between 1 to 5 years depending on various factors, such as the sector of focus, whether the firm is a new or emerging manager, and the VC's brand strength and past performance. This is typically where Old Street Ventures comes in. We aim to build relationships with successful GPs, evaluate their team, strategy and take on an LP position on the next fund they raise.

Stage 2: Investment

Once the fundraising stage is complete, the investment phase commences. The general partner identifies specific targets for investment, conducts due diligence, and places investment capital into selected companies. The process involves issuing capital calls to investors and receiving their funds, which are then transferred to startups in exchange for equity stakes. At this stage, your investment will begin to be deployed into up-and-coming startups as more and more capital calls are made. And as OSV partners up with multiple top-tier VCs, your money doesn't sit around for long but is put to work backing a variety of young startups.

Stage 3: Value Creation

In this stage, the general partner actively monitors its investments, engaging regularly with target companies and providing guidance and strategic advice where needed. While venture funds do not typically assume management roles in their investments, as seen in other types of private equity funds like buyouts, GPs often collaborate with the company's founders and management team at a strategic level, offering their expertise and connections. They also report back to their LPs on how the startups are doing – meaning you get to see how your stake is doing and providing a basis for valuation of your overall investment. Whether you want to be involved in just the early stages or are along for the whole ride, with OSV you'll get the insights and it's up to you.

Stage 4: Exits

The exit stage involves working with target companies to identify and arrange exits that enable the return of capital to investors through distributions. These exits may take the form of IPOs, acquisitions, or secondary sales to other funds or investors. The complexities of such exits often result in longer holding periods for venture capital funds compared to other private equity funds. When startups exit capital is returned to the VCs, who then distribute it back to their LPs. OSV collects the distributed capital and puts it back to work on the next fund, so your investment is always making a return. And don't worry, you can still cash out when you like as we'll always keep some cash on hand as part of our risk management strategy.

Let's Recap

Venture funds have long captivated investors seeking opportunities to support early-stage, private companies with the potential to become the next industry giants. Notable success stories like Google, Airbnb, Uber, Facebook, Zoom, SpaceX, Tesla, and Revolut, to name a few, all trace their roots back to venture capital. The allure of participating in game-changing investments before they go public is a unique aspect of venture capital, offering the possibility of remarkable returns, often reaching 100-1000 times the initial investment for some startups. Beyond the exciting prospects of driving technological advancements and witnessing new business models unfold, venture investments historically outperform public equity and other private investment categories. The rewards and potential impact of venture capital make it an appealing option for forward-thinking investors seeking growth and innovation.

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