Even though the reasoning to invest money into venture capital (VC) funds may vary according to the type of the investor, according to Bygrave et al. (1999), the main reasons include:
First, investors expect high returns on capital invested into VC funds. While a return of 30% p.a. was common, most investors nowadays are seeking for consistent 15-25% p.a., which is in line with comparing portfolio companies to quoted companies and adding a risk premium. Second, since VC target companies have a low correlation with quoted stocks, investors might aim for diversification effects for their overall portfolio. Third, as VC investments are highly illiquid, they provide a return premium. Moreover, the long-term horizon these investments especially fits investors, such as pension funds which have long-term liabilities. Fourth, beyond financial reasoning, investors might also consider VC due to relatively cheap access to the research and development of young companies, leading towards new ideas and products. However, since focus is shifting towards later-stage financing, this becomes less prevailing. Lastly, since young companies typically realise fast growth, they tend to create significant employment possibilities and thus represent a further investment objective of especially government-related bodies.
A further reason includes that many start-ups remain in the private market for many years, due to the large supply of private capital as well as the scrutiny of public markets. This phenomenon results in start-ups realising their high-growth phase while still being private. As a result, investors increasingly turn to the private VC market in order to benefit from these high-growth phases. Besides, investors in the VC market may aim to escape the high volatility inherent in public markets due to its very liquid nature.
Table of Contents
1. THE REASONS FOR INVESTORS TO PUT THEIR MONEY INTO VENTURE CAPITAL
2. THE TYPICAL INVESTORS’ REQUIREMENTS TO INVEST IN A VC FUND
3. THE STANDARD TERMS AND CONDITIONS IN THIS TYPE OF INVESTMENT
Objectives and Core Topics
This work examines the primary motivations for investors to allocate capital into venture capital (VC) funds and explores the critical decision-making criteria used by investors when evaluating these opportunities. Additionally, it provides an overview of the standard legal and operational terms and conditions that govern these specialized investment vehicles.
- Motivations for VC investment, including return expectations and diversification
- Key decision drivers for limited partners (LPs)
- The role of the management team and track record in fund selection
- Standard operational terms such as fund life, fees, and distributions
- Governance structures and the function of advisory and investment committees
Excerpt from the Book
1. The reasons for investors to put their money into venture capital
Even though the reasoning to invest money into venture capital (VC) funds may vary according to the type of the investor, according to Bygrave et al. (1999), the main reasons include: First, investors expect high returns on capital invested into VC funds. While a return of 30% p.a. was common, most investors nowadays are seeking for consistent 15-25% p.a., which is in line with comparing portfolio companies to quoted companies and adding a risk premium. Second, since VC target companies have a low correlation with quoted stocks, investors might aim for diversification effects for their overall portfolio. Third, as VC investments are highly illiquid, they provide a return premium. Moreover, the long-term horizon these investments especially fits investors, such as pension funds which have long-term liabilities. Fourth, beyond financial reasoning, investors might also consider VC due to relatively cheap access to the research and development of young companies, leading towards new ideas and products. However, since focus is shifting towards later-stage financing, this becomes less prevailing. Lastly, since young companies typically realise fast growth, they tend to create significant employment possibilities and thus represent a further investment objective of especially government-related bodies.
A further reason includes that many start-ups remain in the private market for many years, due to the large supply of private capital as well as the scrutiny of public markets (Economist, 2015; Erdogan, Kant, Miller, & Sprague, 2016). This phenomenon results in start-ups realising their high-growth phase while still being private. As a result, investors increasingly turn to the private VC market in order to benefit from these high-growth phases (Bender, Kupor, & Evans, 2015).
Besides, investors in the VC market may aim to escape the high volatility inherent in public markets due to its very liquid nature (Strumpf & Light, 2016).
Summary of Chapters
1. THE REASONS FOR INVESTORS TO PUT THEIR MONEY INTO VENTURE CAPITAL: This chapter outlines the financial and strategic motivations for venture capital investment, highlighting returns, portfolio diversification, and access to innovation.
2. THE TYPICAL INVESTORS’ REQUIREMENTS TO INVEST IN A VC FUND: This chapter details the six main drivers of investor decision-making, including market analysis, investment strategy, management team quality, and historical track records.
3. THE STANDARD TERMS AND CONDITIONS IN THIS TYPE OF INVESTMENT: This chapter provides a comprehensive breakdown of technical fund structures, ranging from fund size and management fees to distribution waterfalls and governance committees.
Keywords
Venture Capital, Limited Partners, General Partners, Fund Management, Internal Rate of Return, Diversification, Investment Strategy, Capital Call, Management Fee, Waterfall Principle, Clawback, Private Equity, Asset Allocation, Due Diligence, Exit Strategy
Frequently Asked Questions
What is the primary purpose of this paper?
The paper aims to explain the financial motivations behind venture capital investments and the key factors investors consider when evaluating funds.
What are the central themes of the work?
The central themes include investor expectations, the criteria for selecting a VC fund, and the structural, legal, and economic terms governing these partnerships.
What is the primary research goal?
The goal is to provide a structured overview of why and how investors participate in the venture capital market.
Which scientific or analytical method is used?
The work relies on a systematic review of financial literature, industry standards, and established economic theory regarding private market investments.
What does the main part of the document cover?
The main body focuses on the six drivers of VC investment, specific operational terms like fund size and closing, and the mechanics of financial distributions and governance.
How can one define the characteristic keywords for this work?
The keywords center on the operational and economic terminology specific to the venture capital and private equity industry, such as IRR, capital calls, and management structures.
What role does the 'clawback' provision play in VC funds?
The clawback provision ensures that general partners do not receive more than their agreed-upon share of profits, protecting investors if performance declines in later years.
How do management teams impact an investor's decision?
Investors evaluate the team's past experience, their alignment of financial interests with the investors, and their ability to add value to portfolio companies throughout the investment cycle.
What is the significance of the waterfall principle?
The waterfall principle defines the specific sequence of how dividends and capital are distributed among general partners and limited partners, including hurdle rates and carry payments.
- Quote paper
- Anonym (Author), 2018, Venture Capital. An Overview, Munich, GRIN Verlag, https://www.grin.com/document/463828
