Peter Wendell’s VC Boot Camp
Scott McGaraghan and Juan Posada, MBA2s
Issue date: 11/12/01 Section: News
- Page 1 of 1
What’s a limited partner, and what kinds of return do they look for? How does a VC identify potential investments? And what’s the difference between VC and private equity anyway? The 120 attendees of the recent VC Basics Breakfast Briefing got answers to these questions and more on Wednesday, October 17th.
Peter Wendell, Founder and General Manager of Sierra Ventures, led an hour-long presentation, schooling first and second years alike on the basics of the venture capital industry. The talk was the first of six events planned as a part of the VC Club Speaker Series for 2001-2002.
Although a newspaper article cannot do justice to the energy and enthusiasm Mr. Wendell brought to the presentation and inspired in the audience, the following includes some of the main takeaways for those who were not able to participate.
VC Industry Introduction
The lecture began with a spot quiz about the venture capital industry. According to Mr. Wendell, venture capital only plays a role in about one percent of the new business started every year. However, venture-backed companies comprise over 50% of high growth companies.
As a result, although venture capital is only involved in a small portion of total business creation, the evidence seems to indicate that venture funding improves a company’s odds of growing quickly. This presents a strong case for a VC claiming as its value the intersection between ideas and capital.
Limited Partners
Capital for a venture capital firm’s investments come from its Limited Partners, or LPs. Typically, LPs are institutional investors (such as pension funds), endowments (such as Stanford’s endowment), and high net worth individuals, who are often successful entrepreneurs or venture capitalists themselves. LPs invest in venture funds because of a VC’s track record in identifying opportunities and growing them to produce superior returns.
LPs typically expect returns that are 3-5% higher than they could get in the public markets (net of expenses and carried interest – more on this below) as a result of the increased risk that they are taking on. In addition, the LP’s investment is illiquid for a period of years, and they will not have access to the returns until a liquidity event such as an IPO or acquisition occurs.
When a VC firm raises a fund, they get commitments from their LPs, but LPs only pay into the fund on an as-needed basis (capital call). Similarly, returns are disbursed back to LPs on a set schedule, which varies from firm to firm. This is why it is difficult to measure returns on a particular fund.
The Role of the Venture Capitalist
The role of the venture capitalist, then, is to source, screen, and select investment opportunities, on behalf of the LPs. For this service, the VC is compensated in two ways. First, the firm charges a management fee, which is a set percentage of the total fund per year (usually 2-3%). In addition, the VC firm retains a portion (usually around 20%) of the returns, called the firm’s carried interest, or carry. More successful VC firms will be able to retain a higher percentage of their returns.
Because of the speculative nature of VC investments, about 40% of venture-backed firms will fail. However, one “star” investment can more than make up for these failures.
VCs try to increase their odds by engaging in portfolio management, the phrase used to describe their Board level involvement with companies in which they have invested. In this capacity, a VC will help to put a management team in place, and decide the strategic direction of its portfolio companies. Both in the sourcing process and in portfolio management, a venture capitalist relies heavily on the strength of his or her Rolodex.
Firms vary widely in terms of their geographical and industry focus, the stage at which they invest, how they screen investment opportunities, and other parameters, which will be covered and explained in more detail in subsequent VC Club Speaker Series events.
What’s Next?
In November, the VC Club Speaker Series continues with a panel discussion entitled “Understanding the Early Stage Financing Industry.” Moderating this panel will be professor Chuck Holloway. Confirmed panelists include Len Baker of Sutter Hill Ventures, John Zeisler of Nokia Venture Partners, and angel investor Ken Coleman. Students will hear perspectives on different approaches to sourcing, selecting and investing.
Peter Wendell, Founder and General Manager of Sierra Ventures, led an hour-long presentation, schooling first and second years alike on the basics of the venture capital industry. The talk was the first of six events planned as a part of the VC Club Speaker Series for 2001-2002.
Although a newspaper article cannot do justice to the energy and enthusiasm Mr. Wendell brought to the presentation and inspired in the audience, the following includes some of the main takeaways for those who were not able to participate.
VC Industry Introduction
The lecture began with a spot quiz about the venture capital industry. According to Mr. Wendell, venture capital only plays a role in about one percent of the new business started every year. However, venture-backed companies comprise over 50% of high growth companies.
As a result, although venture capital is only involved in a small portion of total business creation, the evidence seems to indicate that venture funding improves a company’s odds of growing quickly. This presents a strong case for a VC claiming as its value the intersection between ideas and capital.
Limited Partners
Capital for a venture capital firm’s investments come from its Limited Partners, or LPs. Typically, LPs are institutional investors (such as pension funds), endowments (such as Stanford’s endowment), and high net worth individuals, who are often successful entrepreneurs or venture capitalists themselves. LPs invest in venture funds because of a VC’s track record in identifying opportunities and growing them to produce superior returns.
LPs typically expect returns that are 3-5% higher than they could get in the public markets (net of expenses and carried interest – more on this below) as a result of the increased risk that they are taking on. In addition, the LP’s investment is illiquid for a period of years, and they will not have access to the returns until a liquidity event such as an IPO or acquisition occurs.
When a VC firm raises a fund, they get commitments from their LPs, but LPs only pay into the fund on an as-needed basis (capital call). Similarly, returns are disbursed back to LPs on a set schedule, which varies from firm to firm. This is why it is difficult to measure returns on a particular fund.
The Role of the Venture Capitalist
The role of the venture capitalist, then, is to source, screen, and select investment opportunities, on behalf of the LPs. For this service, the VC is compensated in two ways. First, the firm charges a management fee, which is a set percentage of the total fund per year (usually 2-3%). In addition, the VC firm retains a portion (usually around 20%) of the returns, called the firm’s carried interest, or carry. More successful VC firms will be able to retain a higher percentage of their returns.
Because of the speculative nature of VC investments, about 40% of venture-backed firms will fail. However, one “star” investment can more than make up for these failures.
VCs try to increase their odds by engaging in portfolio management, the phrase used to describe their Board level involvement with companies in which they have invested. In this capacity, a VC will help to put a management team in place, and decide the strategic direction of its portfolio companies. Both in the sourcing process and in portfolio management, a venture capitalist relies heavily on the strength of his or her Rolodex.
Firms vary widely in terms of their geographical and industry focus, the stage at which they invest, how they screen investment opportunities, and other parameters, which will be covered and explained in more detail in subsequent VC Club Speaker Series events.
What’s Next?
In November, the VC Club Speaker Series continues with a panel discussion entitled “Understanding the Early Stage Financing Industry.” Moderating this panel will be professor Chuck Holloway. Confirmed panelists include Len Baker of Sutter Hill Ventures, John Zeisler of Nokia Venture Partners, and angel investor Ken Coleman. Students will hear perspectives on different approaches to sourcing, selecting and investing.