What are venture capital funds?
A VC fund is an investment vehicle managed by a VC firm. The investment managers of the fund are known as General Partners, or GPs. The money they are managing are provided by Limited Partners, or LPs. On average around 85% of LP capital is institutional (e.g. pension funds, endowment funds, etc), with only around 15% coming from ultra high net worth individuals. It is the job of the GPs to manage the capital of the fund and to deliver a risk-adjusted return to their investors, the LPs. They are also supposed to provide value-add to their portfolio of startups beyond capital to help ensure the success of those companies and attract top startups.
VC funds tend to invest in a portfolio of companies, assuming that some will fail to deliver a return at all (ie, that all capital will be lost on those investments), some will only just return invested capital, and that only a minority of the investments will return much more than the total capital invested in the portfolio. VC funds are compensated through a combination of management fees, which help to cover personnel and other costs related to sourcing, funding, and supporting portfolio companies through exit or IPO, and carried interest or carry, which is a percentage of profits.
A typical VC fund targets an average lifetime of 10 years, though it has been reported that the average fund can extend beyond this period until all capital is paid off due to the time it can take some promising investments of the fund to IPO or exit. As an asset category, VCs deploy roughly $25-60 billion a year in the US depending on the year, about the same amount of capital as US angel investors. Although most GPs aim for a market-beating IRR (e.g. 20-30% vs 9-10%), as an asset category, the average VC fund has historically underperformed public market benchmarks such as the S&P 500 and Russell 2000. On the other hand, top-performing VC funds have consistently outperformed the S&P 500 and Russell 2000, including across multiple “vintages”, or funds in a series started by the same money managers. Unfortunately, these VC funds are frequently impossible to invest in as a newcomer, as they have a captive audience of original LPs.
VC funds tend to be large--sometimes over $1 billion in a single fund, and frequently a few hundred million dollars per fund. Some LPs see this as a benefit, as the fund is able to provide follow-on capital to its portfolio, whereas other LPs see this as a disadvantage, as it may be difficult for the GPs to deploy the capital in enough high-promise opportunities to move the needle on the fund, forcing the GPs to invest in lower quality opportunities. In addition, LP capital is sometimes held captive for long periods of time within a fund before it is deployed. As a result, some VC funds, like the online VC fund FundersClub, purposefully limit their fund size and seek to deploy capital more quickly.