Pentrepreneurs aspire to raise money from venture capital funds or Venture Capital (VC), however, in Mexico, only 0.06% of GDP is invested in the information technology entrepreneurship market, while in Chile and Colombia double is invested in relative terms, according to the IMCO.
It is understandable that not every entrepreneur receives capital because venture capital funds are institutions whose administrators or general partners (GP) are obliged to provide a return to their respective investors, so their mission is to invest in projects that ensure high returns with the lowest possible risk in the segment.
How does venture capital work?
The managers of a venture capital mutual fund must raise money from larger investors and sign an investment commitment with them.
These investors are called limited partners (LP).
Once they have gathered the expected capital commitments, the GPs launch themselves into the task of recruiting companies that are consistent with the investment thesis that they promised to their respective investors, this means that each fund has a specific profile of what type of companies will invest. This is usually a number of industries and specific stages in the life cycle of companies, however, it can vary wildly from fund to fund.
Now, the venture capital funds do not receive the capital in a liquid way, they only receive approximately 2% of the money committed for operating expenses and the rest must be requested from their investors or LPs each time their investment committee finds a project that meets your expectations.
Every time they recruit and select a company to place the funds and they have passed the investment committee and the due diligence or legal audit, the administrators of the fund make a capital call to request the money from their investors, which "takes approximately two-four weeks to arrive from the moment it is requested”, according to Cerda, a partner at G2 Momentum Capital.
It is important to mention that these types of funds generally do not invest alone, but in a round of, for example, a million dollars, there is a leader and at least a couple more "followers" who co-invest with him to mitigate the risk.
How do they get the returns?
VCs finance the first years of operation of promising companies, usually with finished and proven products, that need funds to initiate aggressive market expansion in high-growth sectors. For example, in 1980 in the United States, 20% of venture capital was invested in energy companies while by 1998 25% of the capital was invested in the internet industry, according to an article in the Harvard Business Review.
Venture capital in Mexico expects return rates of 20 to 30% per year throughout the life of the fund (which has an average life of 7 years, according to Harvard Business Review).“Of these yields, after returning the capital and an agreed minimum yield, the GPs will keep between 20 and 30% of the surplus, as agreed, and the LPs will receive the rest,” says Cerda.
But as expected, not all companies give the same returns and in some cases, they can fail because it is invested in the early stages and this represents a very high risk.
“More or less, out of every 10 companies, one gives spectacular returns of up to 50x; three give good returns and grow healthy; the others are going to give a minimum return or they will be totally unsuccessful”.
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