What is Venture Capital and How Does it Work?

Information on jobs in venture capital, the differences between venture capital and private equity, and more.

Posted February 3, 2023

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Table of Contents

Venture Capital: An Overview

When entrepreneurs want to start a business, one of the first things they need to do is secure financing. Venture capital (VC) is one of the options that entrepreneurs have for that financing: it is the money that’s given to startups to help spur their growth. New startups often turn to venture capital because they are too new, and therefore too risky, for more traditional forms of financing like bank loans. Instead of repaying the loans with added interest, VC firms usually require a portion of ownership of the startup instead. In return, they get a say in the future strategy of the company and hope to see large returns when the country is acquired or goes public.

By its nature, venture capital investments are risky and the possibility of large losses is built into the VC model. Venture capitalists make the bet that a few very successful companies will pay dividends that can offset the failed investments. Regardless, VC funds provide new businesses with the chance they need to be successful in an otherwise difficult financing environment.

Those who invest money in venture capital funds that are then in turn put into companies or even large venture capital firms are called limited partners, or LPs. Those who manage the fund and work with the individual companies are the general partners or venture capitalists. The general partners work closely with the companies they invest in to ensure that the company is growing profitably. Because of the nature of the financing, relationships between the venture capital firm and the companies can last for 5-10 years before any money is repaid. At the end of the investment period, venture capital funds can sell their shares back to the owners or through an initial public offering.

How Does it Work?

At the very beginning of the startup’s life, companies often “bootstrap,” or use personal funds or the funds of friends and families to jumpstart operations. When that financing is no longer sufficient and the startup needs to scale, founders will begin to turn to more formal financing sources.

Venture capital is a good first choice for startups because of its aforementioned built-in risk and nontraditional repayment options. There are many different VC firms out there–some target specific industries, geographical areas, or stages of company development. Companies looking to source money from VC funds should first create a pitch deck to send to the firms that are a good fit for their business. If they are interested, they will do their due diligence and analyze the potential of the startup.

If both parties agree that it is a good fit, the general partner will present a term sheet that will include the amount to be invested, the equity stake the fund will receive, and any other conditions present in the deal. Most of these conditions are negotiable and the startup should make clear its priorities internally before entering those negotiations.

Most of the funding from VCs goes into the adolescent phase of a company’s life cycle when it is difficult to predict its financial success and the money from VCs is not a long-term investment. These firms typically want to invest money early in the company’s lifetime, help it get to a self-sufficing size, and then receive their return on investment once the company is sold or goes through an IPO.

Venture Capital vs. Private Equity

Often confused for one another, venture capital and private equity (PE) can overlap but operate on distinct business models. Both VC and PE are a means of providing financial investment to companies. However, the kind of business they invest in, the stake they require, and the exit strategy are different.

Venture capital firms like to invest in start-ups and companies going through their “adolescent” phase. While typically at higher risk, they also have the potential for higher returns. In return, the company offers a minority stake. Once the company is sold or goes through an IPO, the VC will typically cash out and move on to its next venture. Until that point, the venture capital firm is invested in the success of the company because they want a substantial payout.

Private equity firms have a different approach. Instead of startups, they will usually invest in companies that are established but struggling because of management or processes. Private equity firms require a majority stake in the company because they are not just providing funding; rather, the PE investors will try and make significant improvements from within the company with the goal of reselling the business for a profit. Though it typically has a lower return on investment than venture capital, it is also taking on a lower risk for a lower amount of time.

Read more about private equity here: (What is Private Equity and How Does it Work?)

Jobs in Venture Capital

From an entry-level position to management, those who work in venture capital are all responsible for the sourcing and supporting of deals. The entry-level jobs available at VC firms are typically “VC Associate” roles. Associates will do most of the sourcing and screening of potential companies. They will call companies, set up meetings, and eventually present prospective companies to the firm’s partners. Associates will also support the companies in which the firm has already invested. This may include running analytics on the company’s health and doing other forms of due diligence.

Most VC associates do not yet have their MBA and are expected to get one. In fact, some Associate contracts are only for two years for this reason. Post-MBA associates are more on the track for firm partnership. The traits required vary dramatically depending on if the firm specializes in early-stage or late-stage deals and if it is industry-specific or takes a broader approach. Generally, VC associates are paid an annual salary of $75,000 to $150,000 and will also receive bonuses based on their performance and the deals they’ve been involved in.

Final Note

Jobs in venture capital are competitive but with the right help, they are attainable. Leland provides you with the content, community, and coaching that you need to get into your dream venture capital job and accomplish other ambitious goals. Sign up today to gain access to additional free resources, community events, small group classes, world-class coaching, and more.

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