How Venture Capital Works

What do Venture Capitalist do?

As little as possible

OK, so we’re only half kidding with the short answer. Most people think that a venture capitalist is just a banker with a bunch of cash waiting to make some investments. The reality is that a venture capitalist is more of a partner to assist in the growth a startup company, and ultimately to the eventual sale or IPO of the company.

Sort out the Good Deals from the Bad Ones

Remember that for a venture fund to exist, it must be managed by venture capitalists who know how to make smart investments in startup companies that show a great deal of promise. Unfortunately most business plans are dogs, sos it takes a solid venture capitalist to separate the wheat from chaff.

VC’s therefore spend most of their time sifting through deals looking for the few that they want to invest in. It’s not uncommon for a VC to pour through hundreds of potential investments looking for just one deal that they want to get behind.

Part of the reason a VC has to be so selective is because they only have a limited amount of time that they can invest in any one deal. Doing a venture investment is not at all like writing a check for a loan. In order for a VC to get their money back, their investment must be managed directly from inception to maturity by the venture capitalist.

Providing Direction and Strategy

Since a venture capitalist typically invests in many companies in the same industry, they often have a great deal of knowledge about what is going on across the industry. This provides a valuable resource to entrepreneurs to understand new trends and take advantage of them.

The entrepreneur often gets so buried in their business that it’s hard to look up and see what else is going on. The venture capitalist, by comparison, is constantly looking at other companies and opportunities, which they can then turn the entrepreneur on to.

Many startup companies will rely on this insight from VC’s to provide direction and strategy as they grow. It’s difficult to quantify how valuable the information a venture capitalist may have.

Help recruit talent

Another valuable contribution that venture capitalists make is the effort to recruit top management talent to the company. Since VC’s work with lots of other startup companies they are constantly shuffling talent from one firm to the other to make best use of their “best players”.

For example, if a CEO at one of the VC’s portfolio companies had just sold her company she may be a candidate to join the management team for another portfolio company. It’s not at all uncommon for many of the top players to jump from funded company to funded company to help get startups evolving quickly.

Startups often have a very limited rolodex, often limited to the founder or a few management team members. You can think of the venture capitalist like an executive recruiter with a vested interest in bringing the top candidates to your organization.

Find Other Sources of Capital

It’s very rare that a startup company needs only one round of venture capital investment in order to grow. Even a healthy first round of investment will often require more capital as the company hits significant growth milestones in the future.

Venture Capitalists are key sources for finding other capital investors to put more money into the company as it needs it. That’s why you often see a series of investors in a single round investment - they all want to participate in order to collectively win.

There’s another strategy at work here as well - the more venture funds that have money in a deal, the more people that have an incentive to make the deal work. Finding more solid venture funds to invest in a company creates more rolodexes to tap, more portfolio companies to partner with, and more expertise to be brought to the table.