Chapter 78 Section 2 The structure of venture capital

Venture capital funds (Venture Capital Funds) mainly come from two sources: institutions (Institutes) and very wealthy individuals.For example, the foundations of Harvard University and Stanford University belong to the former.Of course, in order to reassure investors, venture capital firms themselves will also take out some money to invest together. A venture capital fund is generally a venture capital company that invites no more than 499 investors (and investment legal persons), including itself, to form a limited liability company (Limited Liability Company, LLC).In order to avoid taxation, funds raised in the United States are generally registered in Delaware, and funds raised in other parts of the world are registered in countries and regions without corporate tax such as the Cayman Islands or the Bahamas (if readers If you encounter a U.S. fund registered in California or New York when starting a business, you must have encountered a liar).Why can't it exceed 499 people?Because according to U.S. law, once a company has more than 500 shareholders, it must announce its financial and operating conditions like a listed company.Venture capital companies do not want the outside world to know the details of where they invest, how their funds are operated, and the shares they hold in the companies they invest in. They generally choose not to disclose their financial and operating conditions, so the number of shareholders cannot exceed 500.At the beginning of each round of fund financing, the venture capital firm must go to Delaware and other places to register a corresponding limited liability company, and the registration documents must specify the maximum financing amount, investment location and purpose.Venture capital companies will set a minimum investment amount as a condition for each investor to participate in this phase of investment.For example, Sequoia Ventures’ first round of financing often exceeds one billion US dollars, and it will require each investor to invest at least two million US dollars.Obviously, this is only available to institutions and very wealthy individuals.

A venture capital company establishes a limited liability company every time it raises funds. Its life span starts from the close fund and all investment projects either recover the investment or close the door. It usually takes ten years. The first few years are investment, and the next few years Years is the return on investment.A venture capital company usually raises money regularly and establishes a venture fund for a period of time.The Fund is jointly owned by all investors.The venture capital firm itself plays a role called general partner (General Partner), and other investors are called limited partners (Limited Partner).In addition to contributing a certain amount of funds, the general partner also manages this round of venture funds.Limited partners participate in the sharing of investment returns but do not participate in the decision-making and management of the fund.This separation of ownership and management rights can ensure that the general investor can invest independently and without external interference.In order to supervise the business operations and finances of the general investor, the venture capital fund must hire an independent financial audit consultant and general attorney (Attorneyin General), and these two people (or companies) do not participate in decision-making.Venture capital is much more dangerous than stock trading. Once you make a mistake, you will basically lose everything.In order to reduce and avoid wrong decisions, and at the same time supervise the investment and capital operation of the general investor for the limited partners, a venture capital fund needs to have a Board of Directors (Board of Directors) or a Board of Advisors (Board of Advisors).These directors and advisors are either business and technology elites, or investors from other venture capital firms.They will participate in the decision-making of each investment, but the decision is made by the general investor.

The legal representatives and fund managers of the general partners of venture capital funds are generally very technically savvy. Many of them are technical elites, and many of them have successfully founded technology companies themselves.For example, John Doerr, known as the king of venture capital in the world, was originally an engineer at Intel Corporation.The founders of the two largest and best venture capital firms in China, Northern Light and Cybernaut, were formerly very successful entrepreneurs.For example, Deng Feng and Dr. Ke Yan who founded Northern Light Venture Capital were originally the founders of Netscreen, the world's largest network firewall company, and they are also experts in network security.Dr. Zhu Min, the founder of Cybernaut, is the founder of Webex, the world's largest teleconferencing technology and service company.In order to ensure the understanding of the most advanced technology, venture capital companies will recruit a lot of technical elites, and also invite outside technical consultants, such as Stanford University professors, to help evaluate each investment.

Once the venture capital fund enters the invested company, it becomes the company's shares.If the company closes, compared with the company founders and ordinary employees, the venture capital fund can give priority to getting back the money after the sale of the company's property.However, the money you can get back at this time is usually not much more than zero.If the invested company goes public or is acquired, the partners either directly recover the investment in cash or obtain tradable shares.Both approaches have their pros and cons, and both are likely to be used.The former is generally aimed at smaller funds and less investment. The general partner will sell all the stocks owned by the fund at a certain time after the invested company goes public or is acquired (usually after the Lock Period). Distribute the income to each partner.In this way, the cost of fund management is lower.But that doesn't work if the fund has a large stake, such as venture capital, which often accounts for more than half of the shares in many semiconductor companies.Because all the shares it owns are sold after listing, the company's stock price will plummet.At this time, the general partner of venture capital must pay the stock directly to each partner, and each partner decides how to sell the stock.In this way, the possibility of the stocks being sold at the same time is avoided.Although the cost of fund management (mainly financial costs) has increased a lot in this way, large venture capital companies must do this. For example, KPCB and Sequoia Ventures each own billions of dollars after Google went public 180 days ago. Stocks, if these stocks flooded into the stock market at once, it would cause Google's stock to plummet, so the two venture capitals distributed the stocks to the limited partners, and they handled it by themselves.In fact, most of the partners did not sell. As a result, Google's stock rose instead of falling after 180 days.

In order to reduce risk, a round of venture capital funds must invest in a dozen to dozens of companies.Of course, in order to invest in ten companies, the fund manager may need to investigate hundreds of companies. The cost of this operation is not a fraction, and must be paid by the limited partners, which generally account for 2% of the entire fund.In order to make money, the general partner of a venture capital company also has to withdraw part of the profit from the money earned by the limited partners, usually 20% of the part above the basic profit (such as 8%).For example, if a venture capital fund earns an average of 20% of profits per year, the general partner will withdraw (20%-8%) × 20% = 2.4%, plus 2% management fee, a total of 4.4%, while the limited partners get The return is actually only 15.6%, which is only three-quarters of the total return.Therefore, the fees charged by venture capital firms are actually very high.

The venture capital firm that manages the venture capital fund itself is also an LLC, and its top manager is the partner of the venture capital firm (Partner).Venture capital companies themselves do not have titles such as CEO and president (VC companies with these titles must be counterfeit). The partners of venture capital companies not only have a high status within the venture capital company, but also call the shots in the technology industry. For example, John Dole, a partner of KPCB, is a director of many listed companies such as Google, Sun, Amazon, and more unlisted companies.When venture capital first entered China, such an interesting incident happened.At a venture capital seminar, many "VIPs" such as CEOs and presidents of the company came. The hostess saw the positions of these people and invited them to the front row.Later, a guest came, and as soon as the hostess inquired who the partner was, she seated him in an inconspicuous corner at the back.The partner sat down in the back row without saying anything.As a result, those CEOs and presidents saw that he sat at the end, and no one dared to sit in the front, because the companies these CEOs and presidents belonged to were all invested by him, and their positions were also appointed by him.This shows the influence of venture capital partners in the industry.

Large venture capital companies have a lot of funds in each round of financing. For example, Sequoia Ventures’ round of funds can easily cost more than one billion U.S. dollars. If each company only invests one or two million U.S. dollars, there are not so many companies to invest in. Second, even if there is, it is obviously unrealistic for the general partner to review tens of thousands of companies in a few years, so each of their investments should not be too small; on the other hand, the newly established companies themselves are very small , especially in the early stage, they only need to raise hundreds of thousands or even tens of thousands of dollars, and big venture capital companies will not participate.The investment in these companies is done by a special kind of venture capitalists—angel investors.

Angel investment is essentially early venture capital.Angel investors, referred to as angels, are often rich people: Many of them have successfully founded companies before, are very keen on technology, and are unwilling to work hard to start a business again, hoping to pay others to do it.There are many people like this in Silicon Valley, and their idea is "I don't want to be the general manager (manager), but only willing to be the director (director)." Some angel investors independently search for projects and invest, but more often several people get together to form a small limited liability company LLC or limited partnership (Limited Partnership, LP for short), usually called an angel investment agency Angel Firm to co-invest.The operation and management methods of angel investment agencies vary widely. In some cases, everyone pools money together and invests together; in others, each person chooses a project for their own investment and introduces it to the agency. The agency will double the amount invested by the angel investor (Match) .In fact, John Doerr and Mike Moritz used this strategy to invest in Google. They each took some money from their own pockets to invest in Google, and at the same time, KPCB and Sequoia Ventures, where they belonged, took out the same amount. (Probably more) money is going to Google too.Of course, some angel investment agencies have more flexible management. When an angel investor invests in a company, other partners can choose to follow up (Follow) or not to follow up (Pass). There is no obligation. For discussion purposes only, use a lawyer and accountant together.

Now that we understand the management structure of venture capital, let's look at how angel investors and venture capital firms invest.