Venture Capital

Early-stage companies can't borrow from a bank. A bank's business is getting principal and interest back, which is why it looks for collateral and steady profits. Lend to a company whose only asset is an office deposit and whose profit doesn't exist yet, and nine out of ten loans don't come back. The problem isn't strict underwriting; the structure simply doesn't fit.

Angel investors filled part of the gap. An individual writing personal checks decides quickly, and the amount is small. So a company that has confirmed the product works and now needs to build a sales organization can fail to find anyone able to put in $2 million at once. It stalls not because the money doesn't exist but because no one is set up to carry that much risk alone.

Venture capital fills that slot by splitting the risk. Money from many people and institutions is pooled into one fund, and the fund is spread across twenty or more companies. Any single investment can fail, but one or two large successes cover the rest and more. Risk that would be unbearable on one company becomes calculable once it is divided across many. And because the return comes from selling equity rather than from being repaid, a company that fails owes nothing — the loss belongs to the fund.

A venture capital firm raises a fund from other people's money, buys equity in a set of companies, and returns cash to its backers by selling those stakes when some of the companies grow large. There are five steps.

1. Raise the fund. The pension funds, corporations and fund-of-funds that put money in are limited partners (LPs); the firm that decides where the money goes and manages it is the general partner (GP). Diligence is heavy and paperwork is long because the money being spent was entrusted rather than earned.
2. Invest. A fund's life is usually eight to ten years, and the first three or four go to deploying capital across twenty to thirty companies. Not concentrating is the premise of the whole structure.
3. Manage. Take a board seat, oversee major decisions, and put more money into the companies that grow. Reserving capital for those follow-on rounds is part of the original plan, not a reaction to it.
4. Realize. Turn equity back into cash, usually by the company being acquired or by an IPO. That event is the exit.
5. Distribute. Principal goes back to the LPs and the remaining gain is split. The common structure pays the GP around two percent of the fund each year to operate and roughly 20 percent of the profit as carried interest.

That structure sets the screening criteria. Across twenty investments, about half lose their principal, several return roughly what went in, and one or two produce the fund's entire gain. So what an investor looks for is not a company unlikely to fail but a company that could grow tenfold. It's why a business growing a steady 20 percent a year — a good business by most standards — gets turned down, and why the questions in a first meeting keep circling back to how large the market could get rather than how safe the plan is.

A company meets this counterpart in three settings.

1. The fundraising process. A partner or associate opens the review, and clearing the internal meeting produces a term sheet, the document that summarizes the terms. Then due diligence tests the metrics and the contracts before the definitive agreement is signed. At Series A scale, first meeting to wire usually takes three or four months.
2. Reporting after the money lands. Metrics and financials go out monthly or quarterly, and the board meeting that follows is where hiring plans and budgets get approved. Without agreeing up front on how each metric is counted, the same number gets re-explained every month.
3. The next round. Whether existing investors put more in reads as a signal to new ones. If the party closest to the company declines to add, incoming investors ask why before anything else.

Where it doesn't fit is equally clear. If there is no path to a tenfold increase in equity value within about ten years, the money is uncomfortable on both sides: the company is pushed toward growth it can't sustain, and the investor can't realize the stake inside the fund's life.

"We're going institutional this round instead of angels — the amount calls for a venture firm."

The size needed has moved past what individual investors cover.

"The associate is positive, but it still has to clear the partner meeting."

One person's view and the firm's decision are separate stages.

"That fund is seven years in, so they're thinking about exits rather than new deals."

Not enough fund life remains for a new investment.

Pagedeck raised its Series A from two institutions. The lead took a board seat, and Grace sends metrics and a cash position in the first week of every month. Mia settling the metric definitions in a written document first was a consequence of that reporting.

The longest part of the review wasn't the numbers, it was the definitions. Retention counted by users and retention counted by revenue gave different figures, so the company decided to report both, with a note on which one each chart uses.

The first assumption is that invested money is the company's money to spend as it likes. It does land in the company's account, so that reading is natural. But the money came from the LPs and the firm is holding it in trust. Which is why spending over a threshold or a change in business direction needs board approval, and why the question of when the stake gets realized arrives as the fund's life shortens. Without that context, an investor suddenly raising the subject of a sale makes no sense.

The second is that taking investment means the business has been validated. Clearing a demanding review is real, so the inference follows. But the investor is operating a structure that spreads across twenty companies and leans on one or two. Any individual investment is a calculated bet, not a conviction, and it assumes half the portfolio loses its principal. That is why a company can announce a round and close its doors a year later. Validation comes from customers paying and coming back.