Venture capital (VC) supports business growth through high-risk investments and aims for high returns on investment. Venture capital companies are formed as limited partnerships, limited liability partnerships, or limited liability companies. Investors who invest in a venture capital fund are known as LPs or limited partners. Investors funding start-up companies are known as general partners or venture capitalists. LPs contribute 99% of the capital fund, while venture capitalists contribute 1%. Returns on investment are distributed to partners in the same percentage as contributed.
Structure of Venture Capital Companies
The structure of a venture capital company is based on the type of ownership, and its success depends on how well a particular company adapts to the way in which it has been built.
Ownership involves conducting VC operations in either a single or a two-tier structure. In a single-tier structure, investors raise funds and make decisions for all investments and divestments. They operate through a committee or board of directors who represent the management and shareholders. To avoid making bad investments, venture capitalists need to develop confidence in the venture capital company management.
In a two-tier structure, investors invest in venture capital funds, and investment decisions are taken by the managements of separate venture capital companies.
Points of comparison between single-tier and two-tier venture capital companies:
In a single-tier venture capital company, the financial interests of existing shareholders are directly affected by decisions on investments. In such structures, shareholders must agree on a price before subscribing investors. In a two-tier structure however, the VC management company can raise funds without agreement, on investment value of previous funds.
Following a call for divestment by the two-tier venture capital companies after a certain period, it is easier for investors to realise profits and recover their investments. Since two-tier venture capital companies manage a series of funds, they are committed to raising resources for funds on a continuous basis. Liquidating investments is also simpler for investors of a two-tier venture capital company than a single-tier firm.
Venture capital companies employing the single-tier structure run potential risks as any resource investment in a company that performs poorly will negate any returns on investments. Although two-tier structures cannot avoid the risk of shareholder decisions in single-tier venture capital companies, it is still the preferred option when it comes to a choice between the two types of ownership structures.
How do Venture Capital Companies Function?
Start-up businesses seeking capital investments are given funds for resources in the form of cash. Venture capital companies make cash investments in exchange for company shares. Even when invested in a high-growth potential company, the percentage of investments made by the venture capital companies is usually small.
Young, unquoted businesses are required to include venture capitalists in the company’s management. Venture capitalists are typically professionals with strong entrepreneurial skills and innovative and advanced business ideas. Their expertise adds great value to a start-up business, and ensures the steady growth of the company.
Requirements for Management, Monitoring and Supervision of Venture Capital Companies
One of the most glaring problems encountered by most venture capital companies in developing and underdeveloped countries is the lack of able venture capitalists. Without a proven record of investment successes, it is difficult to attract potential clients and convince them to make investments. Most venture capital companies are not able to recruit good venture capitalists. This discourages potential investors who aim to reap high returns on their investments.
To counter the above problems, Venture Capital companies need:
To concentrate their efforts on managing investments that are profitable. This also includes assessing the potential of companies requiring capital funds.
Managers and staff who can achieve goals and consistently ensure incentives in keeping with the investors’ interests. The VC management must be capable of taking good investment decisions, structure their deals and supervise investments.
A good supervision and monitoring system that is interactive, and a support system that provides advice on financial strategies, the market, employee recruitment, etc.
Experienced professionals who can provide assistance with managing start-up ventures or expansion of established companies
Selecting Good Venture Capital Companies
Your business requirements will decide the type of venture capital companies you approach. If you plan to start or expand an Internet company, your needs will differ from one starting or expanding a manufacturing business. Do your research before approaching venture capital companies, including acquiring information on the investment portfolio of these venture capital companies. You should make sure the following questions are answered when you are choosing among venture capital companies:
- What type of industry does the venture capital company focus on?
- What kind of businesses does it invest in? Does it fund fresh businesses or already established companies?
- Is the investment sum offered by the VC firm sufficient for your needs?
- Where is the VC firm located? Is it international, national or regional?
- What volume of returns is it expecting on investment?
- Will the VC firm be involved in your business? If so, how much?
Targeting dedicated venture capital companies with proven track records of investment successes ensures the best results for your business.