Whether you’re a founder, software engineer, or designer working in the startup ecosystem, it’s beneficial to you to understand where money comes from and who’s giving it to the startup you work at or founded. This is where you learn that.
Startups are able to operate through funding provided by venture capital firms. In return, venture capital firms are able to get equity from these startups that they hope will give them returns
Venture capital is a very risky business, out of 25 investments, an average of about 2-3 companies may yield returns that make up for the failures for the other companies
Venture capital may often focus on investing in the right team over metrics such revenue
Should I do VC?
You want to learn more about how to invest in startups
You enjoy startups more than working at a big corporate firm
You are a mix of analytical and social and enjoy talking to founders
You are a doer and will go out of your way to find startups
You want to make a ton of connections with entrepreneurs and investors
The Venture Hierarchy
Depending on the fund, the venture hierarchy may look different at every organization but in most cases, this is what you usually will see.
Managing Director / General Partners : Managing Partners/ GPs are at the top of the venture capital hierarchy. Managing directors & general partners are the key decision makers at a fund and lead with the fundraising efforts. GPs and managing directors usually get to where they are through 3 ways:
Coming to a fund as a former successful founder (Balaji Srinivasan from Counsyl to A16z.)
Working their way up the ladder (Alex Ferrarafrom Bessemer Associate to Partner.)
VPs/ Principals : VPs & Principals of the fund lead the day to day deal flow, diligence of deals and more. Most VPs/principals have 5+ years of operator or venture experience.
Senior Associates/Associates/Analysts: This group is at the bottom of the venture hierarchy ladder. In terms of experience, they range from right out of college to pre/post MBAs. Many of these analysts & associates are often also former operators as well. The role of them differs fund by fund but is usually either a mix of the two things below:
Due Diligence: These associates and analysts will work with a principal or GP to do due diligence on deals they come across, create market maps and analysis, and write investment memos.
Sourcing: Associates and analysts will be sourcing companies through networks such as YC, private channels, other VCs they establish relationships with, or though scrapping the internet.
Scouts: Scouts are not full-time salaried employees at a venture fund. Many funds such as A16Z, Lightspeed, and and more often have scouts in order to expand their deal flow and network. Scouts are chosen to be highly connected individuals that talk to startups in the behalf on the fund and deploy capital via a scout fund or by introducing the startups to the fund directly. Scouts make compensation on carry, which is a percentage of profits if the deal they bring to the table has a successful exit.
Early stage VCs are institutions that invest capital in startups
Ran by general partners
Funded by limited partners
Have a strict thesis on what to invest in
Takes longer to do due diligence since decisions must be made by a team
Early stage VC firms typically invest more capital to startups at a later stage (post accelerator)
Notable VCs: Sequoia. A16z, NEA
How do VCs Make Money?
Typically around 2% annually of total fund
Pays the salaries and all of the fund expenses like legal fees
Management fees are paid out each year usually for about 7-10 years or when the fund ends
Profit that the VC keeps after returning all the capital to the LPs
VCs typically get around 20% of profits from carry
VCs that are successful can have carry in the millions
Fund X has a $100M fund. Assuming they have 0 returns, they make $2M each year from management fees.
Assuming Fund X has some amazing companies and after the life of Fund X, they return $200M. They stand to make that $2M each year for the life of the fund + $20M from carry ($200m-$100m = $100m x 0.2 = $20m)