Part 2: How Does a Venture Capital Fund Work
Updated: Jan 29, 2022
Venture capital funding is a great way to start your business. However, there are many factors and possible risks to consider. Whether it’s the most efficient and effective way to raise funds will also largely depend on your business and goals. So before you dive into venture capital funding, it’s important to know how it works.
In this episode of Her CEO Journey™, our guest Vonetta Young, a proud woman of colour and financial advisor, discusses how venture capital funding works and its expected outcomes. She will guide us through the importance of profitability and sustainability as factors that affect capital funding. Lastly, she shares other options for funding that you can consider.
If you’re interested in becoming a venture capitalist or getting venture capital backing, then this episode is for you!
Here are three reasons why you should continue reading:
Learn how venture capital funding works.
Discover the importance of profitability and sustainability when it comes to business funding and finances.
Find out if venture capital funding is right for you — and why it’s fine if it’s not.
Visit our website for more insights on cash flow and profit on the Her CEO Journey™ podcast series!
Chat with a Fractional CFO and receive the benefits of a CFO here!
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[04:47] How Venture Funding Supports Itself
Venture funds and private equity funds get a management fee, which is usually 2% of the amount committed to the total fund.
Management fees keep the lights on and the fund running.
It either falls off or decreases after the first five-year investment period.
LPs tend to be cautious because they only want to pay so much in management fees. Thus, the performance must outweigh the fees.
[07:14] Alignment of Incentives
Management fees are usually not enough for venture funds.
Venture fund managers often bootstrap.
“There is just so much bootstrapping that you have to do because you do have to run your company on very little money… You don’t get management fees until you have commitments. But you can’t get commitments until you have made a lot of investments into starting your firm.”
Most people are unaware that venture and private equity managers usually contribute 1–2% of the committed fund capital themselves.
[09:44] Operating on Tight Funds
A small venture capital tryout fund would be $2–5 million.
Investments are usually required before getting management fees. Even if you get management fees, it might not be much.
2% of $2 million would likely just be pre-seed or a “baby fund.”
[12:00] The Success Rate of a VC Portfolio
The success rate of a VC portfolio isn’t high.
It’s not unusual for a venture capital fund to have half the companies that it invested in to return nothing.
Thus, venture capitalists look for unicorns to make up for the other losses in the portfolio.
“[V]enture capitalists look for unicorns because they have to make up for a lot of the other losses that they have in their portfolio.”
Investment acumen in the venture capital space isn’t as concrete as other spaces.
[15:57] Financial Analysis for Funds
There aren’t any hard-set rules in the venture capital space. Meanwhile, private equity is more rigid because more money is at stake.
Nonetheless, companies with venture capital funding will still need to meet reporting standards. To meet these standards, they need revenue, a viable product, and sales.
Series A is the earliest that a company should have solid financial reporting standards.
Investors need to know your cash flow forecast.
[20:58] The Importance of Profitability and Sustainability
Venture capitalists and founders need to make cash flow sustainability a priority.
In the private equity space, unprofitable companies are rarely bought out.
Assuming that growth and innovation hinges on putting all their money into product development is unhealthy.
“[P]eople think that if you focus too much on making cash or if you focus too much on making profits, then that might somehow deter innovation. And I don’t think that’s the case.”
The assessment in venture capital funding evolves as you go through different stages of your business. This is based on growth assumptions supported by data.
“With every stage, there’s going to be different growth assumptions. And I would hope that those growth assumptions would be more supported by data as those stages went along.”
If your company doesn’t qualify for venture capital backing, then you need to figure out cash flow management and profitability.
“If you’re a company that is probably not going to qualify for venture capital backing, then you of all people are going to need to figure out cash flow management and how to get to profitability sooner than later.”
[28:20] Funding Alternatives
The Boston Impact Initiative gets solid returns from its notes and equity investments.
The venture model isn’t for everyone.
Investors often brand themselves as one or the other, but making a social impact and making money can coexist.
[36:02] Vonetta’s Final Advice to Founders
Starting your own fund is like starting your own business.
Ask yourself why you want to do it.
Cash is king.
Don’t be afraid to ask for help.
“I think a big misconception in the industry [is], I think some people either think that venture capital managers are investing all only their own money or all only someone else’s money, and neither one of those is correct.”
“The venture model is just not made for certain demographics.”
“Not every company needs venture backing, not every company wants to become a Fortune 500 company. It depends… It’s totally acceptable to say, ‘I just want to do make my business big enough to support my community and support my family.’”
“Starting your own fund is very much starting your own business.”
“If you need the support, definitely get it because ultimately, that’s going to make your business better and your business being better makes the world better.”
Vonetta Young is a proud woman of colour who works and manages as a Chief Strategy Officer in her business advisory firm, Vonetta Young Advisors. She provides business and finance consulting to emerging firms. Vonetta finished her undergraduate bachelor's degree in English and Psychology in 2007 at Georgetown University.
After working in the communications field in Media Relations and copy editing, Vonetta took up her master's degree and finished her postgraduate degree in finance in 2013 at the Georgetown University McDonough School of Business.
Vonetta had a long journey as to where she is now, advising people of colour and women in forming their first institutional-quality private equity or venture capital fund. She is also an author and freelance writer for personal essays, memoirs, and fiction surrounding the discourse of race and class in the life of people of colour.
Vonetta currently resides in Washington, District of Columbia, United States.
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