If one needs to fund their startup, they can either do it through fundraising or bootstrapping it. Bootstrapping the company is relatively simple; use savings to get the company off the ground and have it running. Fundraising, well, not so much. It involves pitching one’s deck to get funds from the investors.
However, fundraising is also where big money is. Venture capitalists and angel investors use their funds to invest in a company they like. And sometimes, they can invest up to $100M in a single round. However, the looming question is – How do these firms have so much money? Who funds them?
Usually, Limited Partners, known as LPs, invest in venture capital funds. LPs are people who have high or ultra-high net worth or are institutional investors. Institutional investors are entities such as mutual funds, banks, insurance companies, and university endowments. Yale University’s fund endowment is one of the most successful funds, with a total of $31.2 Billion as of June 2020. VCs that receive endowment funds from prestigious universities are more attractive for other investors too. Sometimes, family offices fund startups. They may even be willing to go a long way to support their preferred companies. Some examples of family offices include Burman Family Holdings, Catamaran Ventures, and Mahindra Partners. Sometimes, these may also be foundations like the Gates and the Rockefeller Foundation, which fund VC firms.
Sometimes, entrepreneur-turned-investors also invest in venture capital firms. Mostly, these entrepreneurs are the ones whose ventures have made it big and were backed by the VC that they are now investing in.
Once the venture firms have raised capital from the LPs, they hire General Partners (GPs). GPs are usually fund managers who make worthy investment decisions. They also invest in companies that aim to maximize profits for the LPs. Their primary responsibilities are to raise funds and source promising startups. They are the intermediary between the LPs and the startups working. They have to deliver the returns back to them while also helping the startups in their capacity.
Once the GPs invest in the startup, they help and wait to get returns on their investment. Meanwhile, they have signed agreement clauses with the VC funders on the percentage of profits as and when the company does well. However, VC funders don’t usually aim to keep their money in the startup for an extended period. They invest until the company reaches certain financial and achieves a good reputation. After that, once the company gets more funding or files for an IPO, it may exit.
Venture capital firms exist based on good financials and the support they provide to the startups. However, entities can fund VCs on their proven track record and the VC team. However, meeting the investors’ expectations while also giving great returns can be a little challenging for the venture capital firm.
This is why they try to invest in industries with significant growth potential at the right time. Moreover, the structuring of the deal is of utmost importance. The logic remains the same – protect the investors’ capital while also giving them space for better deals if the company turns out to be favourable. The margin in the contracts is where the VCs make money.
It is because of the entities that fund VCs that they can further fund startups. They are the backbone who indirectly provide support (monetary and otherwise) to the startups.