What is Venture Capital?
Every day we use different products and services from companies that are backed by venture capital. Still, most people are unaware of the venture capital world or know very little about it.
So today, let’s see dissect venture capital and VC fund and see how you can start one.
What is Venture Capital?
Venture capital is a form of financing that invests capital in emerging startups or small businesses with tremendous growth potential in exchange for equity in the company.
Usually, these companies get investment because they have demonstrated growth in revenue, employees, and the overall scale of company operations.
Venture capitalists (investors working at a VC firm) take calculated risks by financing different startups, hoping that some will make it big and generate massive revenues or eventually sell for a high price.
Still, there is high uncertainty and a high rate of failure associated with VC investments.
What is a Venture Capital Fund?
A VC fund is an investment fund that invests in early-stage startups or emerging businesses with growth potential. These investments offer a high potential return on investment but also come with a high degree of risk.
The fund manager in a VC fund can be an individual; however, many venture capital firms run and manage funds independently. The investors in a VC fund are mostly institutions or high-net-worth individuals.
Typically venture capital funds have an active investment period of about five years. After that active period, the fund enters into a “support period,” which usually is another five years.
During the support period, the fund manager can invest capital earned to date by the fund’s investments if they have performed well. If the investors agree, this support period can be further extended for two or more years.
At the end of a VC fund’s life, the profits are divided among the investors, and the fund manager earns a fee and gets a share of the net profits in some conditions.
How to start a Venture Capital fund?
A compelling value proposition is essential when establishing a new Venture Capital Fund. The right fund structure can help fund managers build a compelling value proposition and ensure a successful campaign.
The most fitting fund structure for a new Venture Capital fund depends on some factors that include:
- Size of the fund
- Investment strategy
- Industry and stage of target companies
- Tax resident status and level of sophistication of the investors
Depending upon these factors, there are three suitable fund structures in Australia, namely:
- Unit Trusts & Managed Investment Trusts (MITs)
- Venture Capital Limited Partnerships (VCLPs)
- Early-Stage Venture Capital Limited Partnerships (ESVCLPs)
Unit Trust and Managed Investment Trusts (MITs)
A unit trust structure provides significant flexibility and allows for customisable fund structure design. Funds structured as unit trusts are managed by the trustee or have the investment management functions outsourced to an (often related) particular purpose investment management entity.
Investors in a unit trust obtain units and have rights and obligations governed by the unit trust contract.
Unit trusts can invest in any asset class irrespective of the sector and total fund size without any restrictions.
A unit trust is a tax flow-through vehicle, which means that the trust’s income, profits, gains, and losses flow through to the unitholders, which are then taxed according to their respective tax status.
Managed Investment Trusts – (MIT)
A managed investment trust is also a type of trust and an investment vehicle for foreign investors as it offers the benefit of concessional withholding tax treatment.
Under the MIT withholding tax policy, foreign investors from a country exchanging information on taxation matters with Australia are eligible for a reduced withholding tax rate on fund payments from an MIT.
Venture Capital Limited Partnerships (VCLPs)
The VCLP was introduced to encourage foreign investment in Australian venture capital. It provides an exemption from income tax on profits (capital and revenue) to foreign investors (but not to Australian resident investors).
Funds structured as VCLPs are managed by the fund manager or have the investment management functions outsourced to an (often related) particular purpose investment management entity.
Investors in a VCLP obtain limited partnership interests and have rights and obligations governed by the limited partnership contract. Unlike standard incorporated limited partnerships, the VCLP is a tax flow-through vehicle allowing distributions to be taxed in the hands of the investors.
However, VCLPs only invest in eligible ventures, broadly excluding investing in specific entities typically involved in property development, land ownership, banking, insurance, and other activities. So, VCLPs restrict the investment’s range of options.
Early-Stage Venture Capital Limited Partnerships (ESVCLPs)
As ESVCLP exempts income and capital gains from taxation in Australia to both local and foreign investors.
The tax-free treatment incentivizes investment in early-stage startups and simultaneously mitigates the risk of early-stage venture capital opportunities.
Funds structured as ESVCLPs are either managed by the fund manager or have the investment management functions outsourced to an (often related) special purpose investment management entity.
As with VCLPs, one of the restrictions of ESVCLPs is that they must only invest in eligible venture capital investments. Also, an ESVCLP must have an approved investment plan which demonstrates a focus on early-stage venture capital.
How to Launch your Venture Capital Fund?
My unique 4-Step Fund Launch Blueprint enables you to start a fund from scratch.
My method will get you involved in the fund formation process first by finding the right deal, structuring the deal, and looking for investors before you spend thousands of dollars on legal fees and documentation.
So, do you want to Create, Launch & Scale an Investment Fund? Book in a FREE session today, and let’s devise the perfect game plan for you!
Here is to your fund success!
Dolly Brtan
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