So what in the world is a VC anyway?

A venture capitalist brings socially critical innovations to the public by investing time and financial capital to help founders commercialize their ideas in exchange for equity in the growing company.

“more than 80% of the money invested by venture capitalists goes into building the infrastructure required to grow the business” (HBR)

Why does VC exist and why are they important?

Venture capital fills a structural hole in capital markets by giving entrepreneurs with an idea or technology a place to get funding when other institutions, such as bank loans or public equity, are legally or practically prohibited from incurring such a high level of risk.

How do VCs make money?

A VC makes a return on investment when the company they are invested in has a liquidity event, or “exit”, such a public market offering or being bought by a larger company.

However, very few of the companies VCs invest in will be “winners.” In fact, many of them may be losses. This is not neccesaily through the fault of the VC, or even the management team of the company, rather that most startups fail because the odds are stacked against a company’s success. Here's an explanation from HBR,

“On average, good plans, people, and businesses succeed only one in 10 times. To see why, consider that there are many components critical to a company’s success. The best companies might have an 80% probability of succeeding at each of them. But even with these odds, the probability of eventual success will be less than 20% because failing to execute on any one component can torpedo the entire company. If just one of the variables drops to a 50% probability, the combined chance of success falls to 10%.”

A venture capitalist’s portfolio is designed for this type of risk. They can achieve the returns they need if only 10% of the companies they fund are successful. This high-risk level is why VCs are incredibly careful in selecting their portfolio in order to give them the greatest probability for a potential winner and why they invest in multiple companies at a time to increase the odds that one is a success (diversification).