20: Entrepreneurial Finance and Venture Capital3 What is an angel capitalist, and how does this type of investor differ from a professional
(institutional) venture capitalist?4 Why do you think that private limited partnerships have come to dominate the venture capital
industry? Can you think of any weaknesses this organisational form might have as a vehicle for
financing entrepreneurial growth companies?CONCEPT REVIEW QUESTIONS 20-2
20-3 THE ORGANISATION AND
OPERATIONS OF VENTURE CAPITAL
AND PRIVATE EQUITY COMPANIES
In this section we discuss how venture capital and private equity companies differ in terms of organisation.
We also discuss how they structure, price and exit their investments.20-3a ORGANISATION AND FUNDING OF VENTURE CAPITAL
AND PRIVATE EQUITY LIMITED PARTNERSHIPSMost of the top venture capital companies are organised as general partnerships, and many of them
are concentrated in California’s Silicon Valley, south of San Francisco. These companies usually begin
the venture financing process by creating a distinct limited partnership fund, often with a dedicated
investment target, such as funding clean-energy startups. Although some venture funds are created by
public offerings of limited partnership interests (which can then be freely traded), the vast majority
are organised and capitalised by private negotiation between the fund’s sponsor and a well-established
group of institutional investors. To say that a fund is capitalised at its inception is something of a
misnomer. In practice, the limited partners make capital commitments, which the general partner then
draws on over time as the fund becomes fully invested. In addition to organising the limited partnership,
the sponsoring company acts as the general partner (and has unlimited liability) over the fund’s entire
life, typically 10 years (though often extendable for up to three additional years). As general partner,
the VC is responsible for: (1) seeking out investment opportunities and negotiating the terms on which
these investments will be made; (2) monitoring the performance of the portfolio (or investee) companies
and providing additional funding and expertise as necessary; (3) finding an attractive exit opportunity,
such as an IPO or a trade sale of the company to another company or investor group, that will allow
the fund to liquidate its investments; and (4) distributing the realised cash returns from these exits to
the limited partners and then terminating the fund. For its services, the general partner receives an
annual management fee equal to 1–3% (usually 2%) of the fund’s total committed capital, as well as an
incentive fee, called carried interest, which is often equal to 20%, on the realised return on the fund’s
investments. It is also worth emphasising that the management fee is based on committed capital,
not on total assets under management or deal value, though this fee often declines after the fund’s
investment period is complete.LO20.2
limited partner
An investor in the fund who
makes capital commitments,
which the general partner
then draws on over time
as the fund becomes fully
invested
general partners
The fund management
company responsible for
seeking out and managing
investment opportunities,
negotiating investment terms,
monitoring performance,
arranging investment exit
strategies and managing
distributions of returns to the
limited partners. The general
partners have unlimited
liability over the life of the
fund
carried interest
A performance or incentive
fee, paid to the general
partner, which is often equal
to 20%, on the realised return
on the fund’s investments