In the world of technology startups, we often hear about venture capitalists. However, we rarely hear explanations about who they are, the role they play, how they operate and how they fit into the bigger funding picture. We’re going to help answer some of those questions here, starting with the most obvious...

What is a venture capitalist?

A venture capitalist or ‘VC’ is, quite simply, an investor. They invest money in startups and high-growth companies in exchange for equity, or more commonly, a share in the company. They are in some ways similar to fund managers, but they are far closer to and more personally involved in their investments (the startups). They tend to specialise and invest within a particular area, for example technology sectors like fintech.

VCs tend to expect a return on their investment within five to ten years © iStock/mediaphotos
VCs tend to expect a return on their investment within five to ten years © iStock/mediaphotos

The return on investment varies, but on average it is expected that the money the VCs invest will be returned between five to 10 years after the initial investment, via the company exiting (selling to another company) or going public.

VCs expect the funds they invest in to approximately triple in value over that time. Although not all of their investments will succeed, VCs expect that by investing in a variety of firms they will spread the risk and find a few runaway successes to mitigate any failures.

How do VCs operate?

Most VC firms have associate and partner levels of employment. Associates usually meet with startups at the initial phase and find potential investments, while partners get involved when the deal becomes more serious.

An associate can be promoted to partner once they’ve generated solid returns to the firm. An average day for a VC would include meetings with companies, networking at various events and researching investments.

Where do VCs get their money?

Most of the money VCs use to invest comes from a variety of external sources such as pension funds, charitable foundations, insurance companies, wealthy individuals and international corporations.

The partners of a VC firm also typically invest their own money into the fund, although it is usually in single-digit percentages of the overall fund, with the majority coming from external sources.

How do VCs invest in startups?

VCs typically invest during what is called the ‘Series A’ round of investment. This is followed alphabetically by ‘Series B’ and ‘Series C’ rounds, which raise increasing amounts as they go and often involve larger numbers of investors at each stage.

Before that you get the ‘Pre A’ or ‘Series AA’ seed rounds, which are the earliest stages of investment with the most risk.

These rounds tend to raise less money than venture capital and include angel investing, family/friend backing and crowdfunding. Angel investors have some similarities to VCs, but they usually operate alone and provide a more advisory role.

What sort of startups do VCs invest in?

VCs tend to focus on investing in risky, innovative startups with high growth potential and crucially, founders with a vision they trust and that they believe can succeed. They also invest in companies that are a little older but at a stage where they have demonstrable results and are focusing on boosting their expansion. Given they invest huge sums into startups it is important that they believe there will be a high return rate if successful.

VCs are less likely to invest in firms that don’t have aggressive growth plans, i.e. companies who prefer to focus on slower but steadier, solid business growth.

How do they decide where to invest?

Many VCs specialise within particular areas: technology or even sectors within technology like security, clean technology or fintech.

VCs will look at metrics like customer acquisition, potential size of the market, solid planning, product traction and customer lifetime value when weighing up a startup. However, at the earlier stage their main focus will be on the founding team and their vision for the business, and whether they offer a great product or service with high potential.

A lot of the success of an investment relies on a good VC/founder relationship where they are able to communicate openly, be flexible, and be able to cope with unplanned and potentially negative events - which is almost inevitable when launching a company.

What else do startups get in return from VCs apart from money?

Although the main focus tends to be on the money that VCs inject into startups, they usually provide far more than just cash. They can act as a sounding board for the founder or founding team’s ideas, offer advice and provide access to their network, just to name a few advantages. Many of them have set up their own company and/or worked within the world of technology or investment, so have invaluable contact books as well as perspectives from personal experience.

How do you become a VC?

There is no single, clear path to becoming a VC, although they do all seem to have high levels of job satisfaction as a common thread.

Some VCs have backgrounds from business schools then investment banking, others have set up and sold their own startups, while others come from more corporate backgrounds. Many have previously been entrepreneurs and see it as a way to stay involved in the world of startups without setting up another business. It is also very common for VCs to have previously been angel investors, ‘caught the bug’ for investing in startups and decided to make it a more formal part of their career.