What even is venture capital · for a startup

A venture capital firm gives a startup cash in exchange for a slice of the company.

A startup is a young company. It wants to grow faster than its own sales can pay for. A venture capital firm (a VC) offers it cash.

In return the startup hands over a slice of itself; a share of everything it will ever be worth. This page follows one startup taking that deal.

A company drawn as a pie on the left, a VC firm drawn as a building on the right, cash flowing to the company and one slice moving to the firm founders VC the company VC firm cash in a slice out
The pie is the company. The green wedge is the slice the VC now owns.

The cash is not the VC firm's own money, but a fund that pension plans and universities handed it to invest.

The VC firm's partners put in a little of their own money. Most of the cash comes from others: pension plans, university endowments, and wealthy families.

They hand it over as a fund: a pot with a name and a deadline. The firm invests it in twenty or so startups.

Three money sources feeding one fund box that a VC firm manages, with arrows fanning out to twenty small startup pies pension plan university endowment wealthy family the fund $100M · ten years VC firm runs it twenty or so startups, a slice of each
The three boxes at the top are where the money comes from. The small circles are startups.

The round names a price for the whole company, so the cash decides how big the slice is.

Before the deal, the two sides agree what the whole company is worth; call it $8M. Add the $2M coming in and the company is now worth $10M.

The VC put in 2 of those 10, so it owns 20%. The founders keep the other 80%. (The numbers are an example.)

A three-line sum, eight million plus two million equals ten million, beside a pie split into an eighty percent founders wedge and a twenty percent VC wedge company before$8M + cash in$2M = company after$10M the VC's $2M is 2 of 10 so its slice is 20% $2M founders $8M, 80% VC 20%
The sum is the deal. The green wedge is the VC's 20% of a $10M company.

Each new round sells a new slice, so the founders' share shrinks while the value of what they hold grows.

A startup raises again as it grows: a seed round, then Series A, then Series B. Each round sells a new slice, so the founders' share shrinks every time.

But each round also prices the company higher. Half of a $200M company beats all of a $0 one.

Four pies on a timeline from the start to Series B, each larger than the last, with the founders' wedge shrinking from all of it to half start not priced founders 100% seed year 1 worth $10M founders 80% Series A year 3 worth $50M founders 64% Series B year 5 worth $200M founders 51% worth $8M worth $32M worth $102M
Each pie is the company at one round. Green wedges belong to investors.

The VC's slice is a special kind of share, so in a cheap sale it gets its cash back before the founders get anything.

The VC's slice is preferred stock; the founders hold common stock. If the company is sold cheaply, the VC gets its cash back first. The founders get whatever is left.

If the company sells well, the VC takes its 20% instead, because that pays more.

Two stacked bars for the same company sold for five million and for fifty million, showing the VC's cash back first in the cheap sale and a twenty percent share in the good sale sold for $5M VC gets $2M back founders $3M VC took its cash back (20% would be only $1M) sold for $50M VC $10M founders 80% = $40M VC took its 20% (cash back would be only $2M) preferred: whichever pays more
Each bar is the sale price, split between the VC (green) and the founders.

Most startups a fund backs fail, so the fund needs one enormous win to pay for all the rest.

Backing young companies is a long-odds game. In one large study, about two in three venture investments lost money. Only one in twenty-five returned ten times the cash or more.

So a fund of twenty startups usually rests on one giant win. That win has to pay for all the losses.

Twenty squares for one fund's startups, sized by what each returned: thirteen small grey ones that lost money, five that returned the cash, one that did well, and one huge win one fund's twenty startups, each square sized by what it returned 13 of 20 lose money lost money 5 get it back 1x to 5x 1 does well 5x 1 huge win 10x or more
Each square is one startup. Grey squares lost money; the big green one pays for the fund.

The fund must hand cash back within about ten years, so the VC pushes for an exit: a sale or a stock-market listing.

A fund has a deadline, usually about ten years. By then the cash must go back to the pension plans and universities. A slice of a private startup is not cash.

So the VC pushes the startup toward an exit. That means being bought by a bigger company, or listing on a stock market. The firm keeps about a fifth of the profit.

A ten-year timeline with investing and growing bands, an exit marker at year seven, and a cash token travelling back up to the fund and out to the pension plan and university VC firm keeps about 20% of the profit pension plan the fund university cash back $ 012345678910 years since the fund started years 1 to 3 investing years 4 to 10 growing, then exits exit at year 7 sold, or listed on a stock market
The green token is cash from the exit, going back up to the fund and its investors.

A startup sells slices of itself for cash, and the VC bets that a few such slices will be worth far more than the cash within ten years.