You ever wonder how some businesses take years to grow, while others can hit unicorn status ($1 billion valuation) in just a year or two?
9 times out of 10 – the fuel and backers behind rapid growth in small companies are Venture Capital (VC) Funds.
A Lucrative Endeavor…
I was talking to a VC fund manager the other week who was paying out monthly distributions to his investors that were more than their original investment!
Pretty awesome right?! Venture Capital may seem like it’s common place today- but it wasn’t always that way. Actually, it’s a fairly recent phenomenon and has gained exponential traction in the recent decades.
Venture Capital – A History…
The first signs of Venture Capital and Private Equity emerged just after WWII to came to a close. Small companies across America started erupting everywhere when interest rates were at all time lows of ~4% (now they are even lower!).
These small companies needed cash.. and they needed it fast if they wanted to beat out their competitors. Banks would issue loans – but the underwriting process took way to long and these entrepreneurs didn’t have a credit history to qualify either.
The America Research and Development Corporation and J.H. Whitney Company stepped in to fill the need.
They would give start-ups money- and instead of requiring interest in return- like a loan – they would take equity(ownership) instead.
Some companies just have really sound business models that make sense. You put in $1…. you’ll make back $2. But most early-stage companies don’t have enough money to grow quickly in order to stay competitive.
Types of Venture Capital
Today, there are hundreds of different niches within Venture Capital. Each fund will generally have it’s own investment thesis.
Typically, they will pick a vertical:
- Fin tech
- or Healthcare
- or Agriculture
But not always. Sometimes they will invest in pre-specified stage of company:
- Seed investments or Series A
- Series B or C fundraising
- Series D or E (late stage venture)
To start a Venture Fund – usually a few people will get together and form an investment thesis. They will form a General Partnership and a Limited Partnership and then raise money from Investors
They take the investors money and then invest it according to their investment thesis.
Venture Capital is considered an alternative investment. Big money investors will often allocate a portion of their personal portfolio to alternative asset classes because they are known to provide better returns than a bland diversified portfolio of public stocks and bonds.
The problem with alternative investments is that you are subject to much higher losses.
A common trend in VC’s – raise $100 million – invest that into about 30 companies over the next couple of years. 20 of those companies probably won’t exist in a couple of years.. 5 will barely be hanging on by a thread.. 3 of them will just break even.. but still a bad investment..
…BUT 1 or 2 of those companies will 100X their revenues and you get a big payout.
Ever heard of the 80/20 rule? Where the highest 20% produces 80% of the results?
Well, in VC it’s more like 98/2 rule. Where your top 2% produces 98% of the results.
Another risk with Venture is that it has a long lockup period – which essentially means that once you put your money in – you can’t access that money for anywhere from 5 to sometimes 12 years!
But the ludicrously high returns make it far worth it…
While it’s a risky game to get into… the payouts are what keep people in the game. Note: before investing in a Venture, there are certain requirements and thresholds you need to meet.
Well, that is about as brief as I can get on Venture Capital – but I’ll keep adding more posts about VC, Private Equity, Hedge Funds and more in the world of funds!
Have a question? What me to cover a specific topic next? Comment Below and I’ll get back to you! Thanks for Reading!