Most venture capital firms in the U.S. operate based on the following organizational structure:
The individuals behind a venture capital firm often organize as a limited liability company. This yields important liability limitations for its members and eliminates double-taxation because this structure is a so-called pass-through entity (not a separate tax entity).
Let’s call this company ABC Venture Partners, LLC.
ABC Venture Partners, LLC then structures the actual fund as a separate Limited Partnership.
Let’s call the fund Millennium Fund LP.
ABC Venture Partners LLC becomes the general partner of the Millennium Fund LP, whereas its investors such as high-net-worth individuals, pension plans, insurance companies, banks, and other so-called accredited investors become limited partners.
While ABC Venture Partners LLC contributes only a nominal portion of the capital (typically 1%-3%) that is pooled in the fund, the so-called committed capital, the investors or limited partners usually contribute the vast majority of the capital (typically 90%+).
Now, it is important to understand that not the venture capital firm, in this case ABC Venture Partners LLC invests in the so-called portfolio companies, but Millennium Fund LP does.
The way profits are allocated obviously depends on the individual scenario, but typically, the fund, here Millennium Fund LP, allocates about 10%-20% to ABC Venture Partners LLC, whereas the fund’s investors receive the lion share of any profits.
So in a nutshell, a typical venture capital firm only contributes about 1%-3% of the money, but rakes in 10%-20% of the net profits. To make this deal even sweeter, the venture capital firm also receives an annual management fee of 2%-3% based on the committed capital in the fund. So let’s say that the fund has $20 million in committed capital, the VC typically receives about $500,000 as a management fee for its trouble every year.
To answer your question if VCs ever keep a portfolio company, it is important to understand that typically only about 2 out of 10 investments become very successful and afford the fund with a lucrative exit scenario. An exit scenario can be an IPO (Initial Public Offering), an acquisition or a merger. Another 2 or 3 usually become somewhat successful and may thus generate some sort of financial returns for the fund, but because the underlying securities are often restricted, the fund can’t resell its ownership interests in these portfolio companies and thus, they have to hold on to them. Out of 10 portfolio companies, about half are either a complete failure or manage barely to survive. The fund will have to hold on to these underperformers as well and do what it can to work with them to increase their economic viability.
VCs are typically not in the business of developing investment opportunities in-house.
I hope this helps.
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