Venture Capital

Venture capital (VC) is financing provided to young, fast-growing private companies in exchange for a share of ownership, usually by specialised funds that pool money from institutional investors. Venture investors accept that most of their bets will fail in the hope that a few will grow into very large companies. Start-ups in software, biotechnology, Fintech (Financial Technology) and crypto have relied heavily on it, because they need money long before they have profits to borrow against.

Venture capital is usually treated as a branch of Private Equity (PE), but the two differ in focus: buyout funds buy control of mature companies, often using debt, while venture funds take minority stakes in early-stage firms and rarely use leverage. In crypto, venture firms invest in company shares, in tokens, or in both, which has created instruments and controversies of its own.

Imagine a gardener who plants a hundred seeds of a rare tree, knowing that most will never sprout. A handful will grow, and one or two may become enormous and fill the whole garden. The gardener does not need most seeds to succeed; one giant tree pays for all the failures.

Venture capitalists work the same way. They give money to many young companies in return for a slice of each. Most of those companies close or are sold cheaply, but a rare success, the kind later called a "unicorn", can return many times the whole fund. That is why investors look for ideas that could become very big rather than ones that will be safely modest.

The modern industry is usually traced to American Research and Development Corporation, founded in Boston in 1946 by Georges Doriot and others to back businesses built on wartime technology. From the late 1960s and 1970s, firms in California's Silicon Valley, such as Kleiner Perkins and Sequoia Capital, set the model of partnerships backing semiconductor, computer and later internet companies. Low interest rates in the 2010s and early 2020s, the ZIRP (Zero Interest-Rate Policy) era, pushed record amounts of money into venture funds, followed by a sharp slowdown when rates rose in 2022.

A venture fund is typically a limited partnership with a life of about ten years. The general partners choose investments and manage the fund. The limited partners supply most of the money; they include Pension Funds, university endowments, insurers, family offices and funds of funds. General partners are commonly paid a yearly management fee of around 2% of committed capital and a share of profits, called carried interest, often around 20%, once investors have their money back. In the United States, the Dodd-Frank Act exempted advisers that manage only venture capital funds from full registration with the SEC, which defined a "venture capital fund" for this purpose in a 2011 rule; such advisers still file reports as exempt reporting advisers.

Companies raise money in rounds, roughly in this order: pre-seed and seed (an idea, a Business Plan and a first product), Series A (evidence of demand), then Series B, C and later rounds to scale. Early rounds often use a Simple Agreement for Future Equity (SAFE) or a Convertible Note, which convert into shares at a later priced round. Priced rounds start with a Term Sheet, pass through Due Diligence (DD) and end with new preferred shares recorded on the company's Cap Table.

The price of a round is set through a valuation. The basic relationship is:

and the investor's ownership is:

Here the pre-money valuation is the agreed value of the company just before the new money arrives, and the post-money valuation is its value immediately after. For example, a fund investing $5 million at a pre-money valuation of $20 million produces a post-money valuation of $25 million, so the fund owns $5 \div 25 = 0.20$, or 20%, of the company.

Venture returns follow a "power law": a few investments generate most of the gains. Investors earn money only at an exit, usually a trade sale to a larger company or an Initial Public Offering (IPO), so funds track paper gains with measures such as multiples of invested capital and Return on Investment (ROI) while they wait. For limited partners, venture is one high-risk slice of a wider Portfolio.

Crypto added new ways for venture investors to take part:

• Token warrants. Alongside ordinary shares, an investor receives the right to a portion of any tokens the company later issues.
• SAFTs. The Simple Agreement for Future Tokens, proposed in a 2017 white paper by the law firm Cooley and Protocol Labs, lets accredited investors fund a network before its tokens exist, modelled on the SAFE. It was designed in response to the Securities and Exchange Commission (SEC)'s position that many token sales are securities offerings.
• Direct token purchases. Funds buy tokens in a private Token Pre-Sale before a Token Generation Event (TGE), typically with lock-ups and vesting set out in the project's Tokenomics.

Large crypto-dedicated funds were raised during the 2021–2022 boom; Andreessen Horowitz, for example, closed a US$4.5 billion crypto fund in 2022. Unlike shares, tokens can trade publicly within months, giving venture investors a faster exit than an IPO.

• Insider advantage. Critics argue that crypto venture investors buy tokens far below public prices and sell when each Token Unlock (TU) arrives, leaving retail buyers holding the losses; launches with a small float and a high Fully Diluted Valuation (FDV) drew particular criticism in 2024.
• Growth at all costs. Venture pressure to scale fast can push start-ups to spend heavily on Customer Acquisition Cost (CAC) and delay the Path to Profitability.
• Access and diversity. Funding is concentrated in a few cities and networks, and studies have repeatedly found that women and minority founders receive a small share of venture dollars.
• Booms and busts. Easy money inflated valuations in 2021, and the later Crypto Bubble deflation left many funds with large paper losses.

• National Venture Capital Association (NVCA)
• SEC final rule: Exemptions for Advisers to Venture Capital Funds (2011)