How Venture Capital Funds Work

If you are seeking out VC funding, it can help to understand how venture capital funds work. The inner workings can give you perspective on how to pitch your business, a critical thing.

The first thing to understand is most venture capital funds are set up as limited partnerships. The “LP” is a business entity that has a general partner and then any number of limited partners. The general partner “runs” the business in that he/she/it makes all the decisions related to the business.


The limited partners buy into the LP for cash, but can’t be involved in the running of the business. Why would they do this? Liability. The general partner is liable for the debts and obligations of the fund. The limited partners are only liable to the extent of their investment, to wit, the money they used to buy in.

So, how about revenue distributions? Well, let’s say the VC fund invests in ten businesses. Three die on the vine, five are moderately successful and two become big hits. This would constitute a great result. In such a situation, the general partner would typically make a two percent fee for running the business and a 10 to 20 percent fee for producing a result. The rest of the money would be distributed to the limited partners per their ownership interest.



So, what should you take out of these figures? The single biggest thing to understand is the motivation of the people you are dealing with. They are with the general partner. Their goal is to make as much money as possible for two reasons. The first is to obviously put money in their own pockets. The second is to produce a good result for the limited partners so that those same parties will invest again in the future.

What about the merits of your business or your lofty business goal? Yes, they have in interest in this, but don’t fall prey to losing site of their real purpose – to make money.

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