Venture Capital Markets
Investment banks are involved with venture capital investments, from raising capital for the funds to taking the portfolio companies public or selling out to other businesses. An investment bank may simply raise money for external venture capital funds. An investment bank, alternatively, can manage the fund itself as part of its merchant banking operations. Even though many venture investments turn sour, the successful ones are so profitable that the overall annual returns have exceeded 40% in recent years. The goal of this chapter is to provide a complete discussion on how to succeed in venture capital investing. To achieve this objective we examine issues such as venture capital fundraising, sourcing, due diligence, investing, risk factors, management fees, profit-loss allocations, exit strategies, and tax and legal issues.
Venture capital (VC) firms make equity investment in entrepreneurial companies. The financiers recoup their investments when the portfolio companies either go public or sell out to other corporations. The VC market includes the merchant banking subsidiaries of large institutions such as investment banks, bank holding companies, industrial companies, and insurance companies. The VC industry also has many specialized investment entities formed principally to make VC or private equity investments. A private VC fund typically raises its capital from a limited number of sophisticated investors in a private placement, and has a life of about 10 to 12 years. The investor base consists of wealthy individuals, pension plans, endowments, insurance companies, bank holding companies, and foreign investors. VC firms receive income from two sources, the annual management fee and profit allocation of the fund. The fund's main source of income is a capital gain from sale of stock of the portfolio companies (the companies in which the fund has invested). The general partner (venture capitalist) typically receives 20% of the profits and the limited partners (capital providers) receive 80%.
A VC fund passes through four stages in its life. The first stage is fundraising. It takes the general partner usually 6 months to 1 year to obtain capital commitment from VC investors. The second stage is to carry out investment. After sourcing a perspective deal, satisfactory due diligence leads to an investment, and the company then becomes a portfolio company. This phase typically lasts for about 3 to 7 years. The next stage, which lasts until the closing of the fund, is to help portfolio companies