How Venture Capitalists Make Money: Exits, Support and Managing Losses
Every business aims to generate profit, and venture capitalists are no different. The investment can last eight to ten years to give the startup enough time to grow and yield profits. At the end of this period the business is expected to reach the Initial Public Offering phase or attract a larger acquisition. The venture capital firm sells its equity to the incoming shareholders and so earns its profit from the merger, IPO or acquisition. From the proceeds, the limited partners are paid for their investment and the remainder is the profit of the firm. The firm may use returns to pursue other ventures. If the business shows signs of failure, the firm can opt out earlier and cash out by selling its equity.
The funding itself is staged. Early-stage funding is called Series A, the growth stage Series B, and the late stage Series C.
Venture capital also goes beyond money. Stakeholders back their portfolio with market surveys, skills, networking privileges, expertise and investigations, often packaged with the investment round. This influence helps place a young venture in good standing in the market, increases the possibility of profit, and lets new companies find synergy with other businesses in the same portfolio. For businesses testing international markets, venture backing can provide the capital as well as the connections and expertise for overseas growth.
Virtually all new companies run a high risk of failure, and venture firms adjust for it. To shield their investment somewhat, stakeholders charge management carrying costs and expenses on top of the benefits from a productive exit. A larger portfolio balances high-risk ventures against growth-phase companies that are more likely to generate returns.
Risks remain outside any investor's control: changes in organizational hierarchy, market loss, bad business choices, competition, recession and other economic conditions. This is why venture capital is called high risk, and why the entrepreneur should understand that the firm will expect an exit.