DEFINITION: The phrase “venture capitalist”—often abbreviated “VC”—refers to an investor who, in return for an equity share, provides funds to entrepreneurs whose young businesses show promise of significant growth.
VC investors may aid both start-ups and smaller firms with growth potential but which lack entry to the stock market.
ETYMOLOGY: The American businessman and investor Arthur Rock is credited with having coined the phrase “venture capitalist” in the 1950s.
The English noun “venture” is attested from the fifteenth century. The related verb derives, via Middle English venturen, from Middle French aventuren, which is related to the noun aventure, meaning “adventure.” The latter derives from Vulgar Latin adventura, which, in turn, derives from the Latin past participle adventus of the verb advenio, advenire, meaning “to come to” or “to happen.”
The English word “capitalist” derives, of course, from the noun “capital.” In the relevant economic sense, “capital” is attested from the seventeenth century.
The noun “capital” derives, via Middle English capitale, from French or Italian capitale, meaning “chief” or “principal.” The latter words ultimately derive from the Latin adjective capitālis, capitāle, meaning “relating to the head,” which, in turn, is from the noun caput, capitis, meaning “a head.”
USAGE: Typically organized as limited partnerships (LPs), venture capital firms have partners who invest in the VC fund. A committee is then appointed that is responsible for making investment choices.
When promising start-up and other emerging companies are selected by this committee, the firm’s capital is used to finance them in return for a substantial equity share.
Contrary to popular assumption, venture capitalists do not typically finance startups from the very beginning.
Rather, they aim to invest in companies that have started generating revenue and need additional funding to bring their concept to the market.
The VC fund acquires a share in these companies, supports their expansion, and aims to achieve a significant return on investment when they cash out.
Venture capitalists commonly search for businesses offering a distinctive product or service, possessing a capable management team, and likely to enjoy a robust competitive edge and so substantial market prospects.
VCs also target sectors they are well-acquainted with and aim for a significant ownership stake in the company, enabling them to shape in its expected growth trajectory.
The reason why VCs are willing to assume the inherent risk of investing in promising start-up and young enterprises is because they have the possibility of reaping substantial returns if the companies take off and become successful.
In short, VC firms often direct investments towards enterprises or projects that traditional banks or capital markets tend to avoid due to the significant inherent risk.
For this reason, venture capitalists experience high rates of failure due to the unavoidable unpredictability associated with new and untested companies.
The pooled funds from which VC firms draw their resources for investment may derive from a variety of sources, including pension funds, insurance firms, corporate pension funds, foundations, and affluent individuals.
The VC firm acts as general partner, while the remaining corporations and individuals become limited partners. All partners hold an ownership share in the fund proportional to their investment. Nevertheless, the VC firm decides upon the allocation of funds.
Managers of venture capital funds receive compensation through management fees and carried interest, while around 20 percent of the profits are allocated to the firm responsible for overseeing the private equity fund.
The remaining portion is distributed among the limited partners who have invested in the fund. In addition, general partners typically receive an extra two percent fee.