Capital Formation

finance a la shmoop- what is venture capital? Google Facebook Yahoo Netflix

LinkedIn snapchat Instagram well they were all originally funded by venture [logos flash across screen]

capital. and the common theme was that two college dropouts built these

companies starting in a garage in Silicon Valley, creating something

dot-com that would change the world. and the world's a mess so it needs a lot of

changing. venture capital comes in a few flavors-

the earliest rounds are called seed capital, and it usually mean that an

original investor put in a few hundred grand, maybe a million or two .the money

was invested at the very beginning of a company when it usually has no revenues [seed capital defined]

no product no nothing. just a hope and a dream and a big idea .and the idea can be

huge. at one point Yahoo's original seed

investment returns 10,000 times its original capital. a regular seed level

investors are called angels and they are typically previously

successful founders or entrepreneurs who want to recycle precious high risk

capital back into the Silicon Valley ecosystem in that form. and yeah Angels [man holding money looks excited]

know that 99 plus percent of their investments go fully bankrupt, but a few

become lottery ticket winners which produce massive returns and those

returns make up for the many many many losses. well once a company has say a

million bucks in revenue and has likely burned through the original seed money

million-ish or so that they raised, well they would then seek to take in what's [money burns in a fire]

called an a round. ie a first level full venture capital round where the company

raises four or five million dollars to then bring it to the next level of

growth. either in product use or revenues or depth and power of its patents or

intellectual properties and so on. anyway later stages of venture capital

investment are cleverly tagged B C and D rounds. and when a company is in the tens

of millions of revenues looking at a hundred million around the corner well

they would raise what is called growth capital- if they're no longer a [people peek around a corner]

speculative venture and they then appeal to a lower risk lower reward group of

investors. so where does the venture capital money come from? well the initial

seed amounts are relatively tiny. a pocket of 50 million dollars might fun

a hundred early startup companies for years and in the scheme of all the

wealth and Silicon Valley well 50 million bucks is just lunch money. a

normal sized venture capital fund might have half a dozen partners and another [business people smile at each other]

half a dozen junior partners .it would raise money from what is called limited

partners and that has nothing to do with the department store. the people

responsible for investing the money diligently are called the general

partners, and for this pleasure the general partners charge roughly 2% a

year in management fees and then they also take a 20 to 30 percent success fee

or carry if their fund pays back all of its initial capital and then has real

profits. so for a normal-size venture capital fund now let's say there's just

four general partners if they raise four hundred million dollars, invest it well

and in say eight years they've produced maybe a dozen IPOs and they've sold [graph showing growth]

maybe a half a dozen other companies so that the 400 million originally raised

has now turned into 2.4 billion dollars well they would show a profit of 2

billion bucks, and if their carry was 25 percent then the partners would split

five hundred million dollars among the four of them. and they'd get that all in

addition to the nice fat salaries they were taking along the way, so yeah it's a

nice work if you can get it and then there's the other side of the street as

an entrepreneur, if you're looking to start any sort of major venture you'll

need to attract some venture capital unless you know you and your buddy in

the garage have a couple mil just lying around with nothing better to do. [two people sit behind computer screens]