Venture Capital and the Structure of the Venture Capital Environment

Venture capitalists are professional investors who manage private equity, investing in young companies at an early phase of their corporate existence and nurturing such companies over the long term with the goal of gaining abnormal returns on their investment. Such investors organize in firms (henceforth VC firms). A VC firm (e.g. Kleiner Perkins Caufield & Byers) is a partnership between individual venture capitalists (the "general partners") that organize for the purpose of managing one or more venture capital funds (e.g. KPCB Java Fund).

A venture capital fund manages assets invested by the general and the limited partners. Typically, the general partners contribute about one percent of the total fund's assets and manage the fund's day-to-day operations. The limited partners, who invest the balance of assets, are passive participants (In order to retain limited liability, the law restricts limited partners from taking an active role in the day-to-day management of the fund.). As compensation, the general partners receive an annual management fee that ranges from one percent to two-an-a-half percent of the fund. In addition, they receive, on average, about 20% of any distribution. The limited partners receive the balance of the distributions.

A 1988 Venture Capital Journal Study found that the majority of limited partners are institutional investors. Of the $2.95 billion raised in 1988, 46% came from pension funds, with an additional 12% from endowments and foundations and 9% from insurance companies. Corporate venture capital subsidiaries accounted for 11% of investments, individuals and families for 8%, and foreign contributions totaled 14%.

The venture capital fund is set up as a limited partnership with a predefined lifetime, usually ten years with an option to extend the fund for up to three additional years. For a VC firm to remain active, a new fund is raised every three to six years - therefore, VCs are repeat players in the investment arena. New funds make most major investments (The companies in which a VC invests are called portfolio companies) within the first four to five years so that investments can be exited and gains distributed within the appropriate timeframe (Gompers 1996). At any given time a VC firm will have a number of funds under management ongoing concurrently.

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Reference

Gompers, Paul A.(1996). Grandstanding in the venture capital industry. Journal of Financial Economics, 42, 133-156.