Venture Capital Funding Basics From A VC

April 28, 2010

12:27 pm

Starting a company is hard enough as it is but one the biggest areas of confusion of entrepreneurs revolves around funding and venture capital. I hope to help calm some of your fears and anwser your questions. So let’s start with the basics so we have a foundation to work from when it come to explaining some of the more complex funding concepts and scenarios.

What is a Venture Capital Fund?
There are many different types of VC funds out there. They all boil down to a group of professionals investing money in startups in exchange for equity stakes in those startups.

Our fund’s money comes from a group of investors & institutions who have agreed to let us invest the money on their behalf for 10 years. If we make a profit on the money invested, we get to split the profit with our investors 80/20. Our 20% is called “carried interest” or just “carry” for short.

What different types of VC funds are there?
Every VC fund has a story, and it’s worth getting to know their story before you pitch your idea to them. Some funds invest nationally, while some are regional. Some only invest in life sciences, while some invest across the board. Some will invest a few hundred thousand dollars in an idea, while others will only invest several million dollars in fully functional businesses. Some investors are passive, while others are active and require a board seat. Every VC fund is a little different. Our fund invests in very early ideas in the Midwest & Texas across IT, life sciences, and materials.

What do VC funds offer startups other than money?
Most VCs will sell themselves as offering more than just cash to get your business running at full speed very fast. Many VCs are successful entrepreneurs in their own right, and can offer a lot of good advice and coaching from their board seat. Because of our equity stake in the business, we also open our rolodexes to help the company as much as possible. The combination of our careers prior to becoming VCs, with the power of sitting on as many boards as we do gives us extremely powerful connections to help our startups.

How close knit is the VC community?
The VC world is very small. There are only 794 active firms per the National Venture Capital Association. With the average firm housing only 3-4 investment professionals, you get the feeling that everyone knows each other. We all hang out at the same conferences and incubators. We co-invest with each other in startups, so we end up being very close knit. Savvy entrepreneurs keep this in mind when networking.

What is diligence and how do you do it?
My first goal with any idea is to understand the core economics behind it. If the idea is interesting, the core economics check out, and our partnership is genuinely interested in pursuing the investment, I will begin to rigorously check out or “diligence” the startup. Diligence requires that I talk to customers, suppliers, competitors and try to validate everything I think I know about the startup. It also involves a lot of time thinking about the business and ensuring that we have a workable game plan that will get my investors a very high return in a relatively short period of time.

I hope these questions have helped your understand of some of the Venture Capital funding basics. If you have more specific questions please post them in the comments sections below and I’ll attempt to anwser them in future articles.

Editor’s Note: This article was written by Aziz Gilani. Aziz is an Associate at DFJ Mercury. He has significant experience as an operator, consultant, and investor in technology companies, with a particular focus on enterprise and consumer software. You can read Aziz’s full bio here. He sometimes blogs over at TexVC and you can follow Aziz on Twitter: @TexasVC.

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Aziz Gilani is a Director at DFJ Mercury. He has significant experience as an operator, consultant, and investor in technology companies, with a particular focus on enterprise and consumer software. You can follow Aziz on Twitter at: @TexasVC

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