The greatest challenge for an entrepreneur to launch his startup and keep the business up and running is to acquire the necessary funds. An entrepreneur can get his/her funding from various sources right from the good old banks to the local (un)friendly money lender. However, the preferred mode of getting investments for today’s startups is venture capitalist firms, popularly called VCs.

Venture capitalists are firms that provide high-risk capital in order to support new companies with the aim of getting bigger returns after a number of years (usually ranging from five to ten). The firms invest in the business, and usually in return for their funding, they purchase a stake in the startup. They nurture it for a short period of time and when the time is ripe, that is when the startup goes public or when it is acquired by a bigger company, they sell their stake and exit. If they hit the right opportunity, they usually make a lot of money, which would have been nearly impossible through normal investment vehicles.

However the question that surfaces is, while the venture capital firms fund the businesses, how do they make the money? It’s a little complicated, but let’s see.

The venture capital firms make money from the rich people who want to keep on increasing their own wealth and are not shy about taking risks. These high net worth individuals have a large risk appetite and can make high-risk investments with the promise of higher returns, some even do it in order to encourage new industries and young and able minds, and solve world problems. Ever heard of the names Ratan Tata or Yuri Milner?

Pension Funds

 Don’t panic, your entire pension money won’t be invested in Zomato or another such startup. There is a tiny percentage of the total corpus that the pension funds are allowed to put in high-risk high-return vehicles like venture capital firms.

Financial institutions

While they might hold the reputation of being shrewd, they are smart enough to recognize a good opportunity. If impressed by the idea, financial institutions don’t mind throwing in their hat (or purse) in the ring and get into funding a new business through a venture capital firm.

Co-investing with other firms

This is a joint effort and a way that venture capitalists can secure more funds and themselves from taking high risk. This adds credibility and increases the ability to invest in more deals.

The Partners

Venture capital firms are made up of general partners and limited partners. The general partners are in charge of finding and agreeing with the startups, then working with them to fully meet their goals. The limited partners are the organizations or people that provide the capital necessary to complete the investments.

The venture capitalists are then compensated in two ways;

The management fees and interests

 Contrary to the popular belief, the venture capital firms make their own money as well. They charge the investors a management fee, which is normally just around 2% of the whole fund. This is used to pay the salaries and fund day to day operations.

The carried interest

Out of the profits made, usually about 20% to 25% of the profits is retained by the firm, while the rest goes to the investors. This helps to add to the coffers of the VC funds.

So through the above means, the VCs remain liquid and keep nurturing the up and coming businesses.

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