A venture capital fund is a partnership that primarily invests the capital of third party investors in enterprises that are typically too risky for ordinary bank loans. Most investments are structured as preferred shares. Their investment criteria usually include a planned exit event (an IPO or acquisition) within three to six years. Because many businesses cannot create the growth required to have an exit event within that timeframe, venture capital is not unsuitable for everyone.
The failure rate of investments can be high; anywhere from 20 to 90% of the enterprises funded fail to return the invested capital. In good times, the funds that do succeed may offer returns of 300 to 1000% to investors.
Venture capital partners (also known as "venture capitalists" or "VCs") may be former chief executives at firms similar to those which the partnership funds. Investors in venture capital funds are typically large institutions with large amounts of available capital, such as state and private pension funds, university endowments, insurance companies and pooled investment vehicles.
Most venture capital funds have a life of ten years. Investors have a fixed commitment to the fund that is "called down" by the VCs over time as the fund makes its investments. In a typical venture capital fund, the VCs receive an annual "management fee" equal to 2% of the committed capital to the fund and 20% of the net profits of the fund. Because a fund may run out of capital prior to the end of its life, VCs may have several overlapping funds at the same time.
The late 1990s were a boom time for the globally-renowned VC firms on Sand Hill Road in the San Francisco, California area. The NASDAQ crash and technology slump that started in March 2000, and the resulting losses on overvalued, non-performing startups, has shaken VC funds deeply. In 2003, many VCs are focussed on writing off companies they funded just a few years ago. At the same time, venture capital investors are seeking to reduce the commitments they have made to venture capital funds. As of mid-2003 conventional wisdom is that the venture capital industry will shrink to about half its present capacity in the next few years.
See also: Private Equity