What is a Venture Capital Fund and How Does It Work?

Private Equity (PE) refers to unregistered equity and equity-linked securities that are sold by private companies or partnerships to financial players. PE covers an array of venture capital, buyout financing, and restructuring capital. Hence, Venture capital is a subset of private equity, which represents a major component in the alternative investment universe. 

Earlier, they made investments only in software and related businesses, but now they have successfully emerged for all the business firms that take up risky projects and have high growth prospects as well. Venture capital in India is provided as risk capital in the form of shares, seed capital, conditional loan, participating debenture and other similar means. 

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Venture Capital (VC)  plays an important role in the development of many sectors of different economies. It is the key driver in innovation, new firm creation, rapid growth of businesses, in promoting entrepreneurship, enhancing competition and job creation. It is the fund provided by the venture capitalists to startups or small companies that don’t have access to capital markets, but they have the long-term growth probability and willingness to enter the equity market. It involves high risks for the investor, but if proven otherwise by the invested company, they have the potential for above-average returns. Another way of forming venture capital is by including managerial and technical expertise that pools such investments or partnerships. This form of raising capital is popular among new ventures with limited operating companies that cannot gain capital by issuing debt. Nevertheless, venture capitalists usually get a share of the equity and rights in company decisions. VC tends to focus on emerging companies, while PE tends to fund established companies as an equity infusion.

(The term VC is derived from the Harvard Business School where a man invested  $2,00,000 into an X-ray machine company, which turned into $1.8million when the company went public in 1955). Today the VC is getting popular due to technological developments due to which the venture capital industry experienced an extraordinary growth over the last decades and is now broadly accepted as an established asset class. VCs.

A Venture Capitalist is an investor who invests their capital to either financially help startup ventures or small companies who want to expand but do not have the access to enter equities financial markets. The reason behind the willingness is to earn a high return on their investments if these companies succeed in the future. On the other hand, they also experience losses when the companies fail, however because the capitalists are wealthy, they can afford such losses and also they are eager to take the risks associated with funding young new companies that appear to have a great idea and a great management team. 

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Venture capital in India has been known since 1975 after three decades from mushroomed in the US. The first VC fund was launched by Industrial Finance corporation of India which rolled out a formal venture capital scheme in the form of interest free loans. Then, in 1988 ICICI and UTI came into partnership to launch a venture capital scheme. Fast forward to today India has a vibrant VC ecosystem. 

(Indian VCs from investing 1037 deals of worth $38B in 2019  to ranked 3rd globally as per IVCA report in 2021 and in 2024 cracking 1270 deals and till June 2025 Indian VCs have  invested in 270 deals worth $7.9B). 

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For venture capitalists it is not an easy task to give funds to any startup and for startup’s too it is not an easy task to do fundraising it is a double edge sword for both the entities.

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To raise funds from venture capitalists they has to go through a process: 

1. Deal Origination:  Deal origination is a process by which firms source investment prospects. An effective deal origination process is fundamental to successful investing. Origination involves generating leads and managing relationships with intermediaries. Strategies for deal origination vary among firms. Deal may originate from referral system, active search and intermediaries. 

2.  Screening: Venture capital financing conducts initial screening of all projects on the basis of some broad criteria. These broad criteria will differ from VCF to VCF company. Some of the criteria may be amount of investment, geographical location of business etc.

3. Due Diligence: Once initial screening is done, the next stage is due diligence. VCF evaluates the quality of the entrepreneur before appraising the characteristics of the product, market or technology. New entrepreneurs asked to prepare a business plan which represents assessment of the possible risk and return on the venture. Risk analysis covers product risk, Market risk, technological risk and entrepreneurial risk.

4. Deal Structure: Once the venture has been evaluated as viable, the venture capitalist and the venture company negotiate the terms of the deal like amount of investment, form of investment etc. In this process negotiations are done between venture capitalist and venture company to ensure protection of their interest.

5. Post investment Activity: Once the deal has been structured and finalized the venture capitalist plays a role of a partner and collaborator. He is involved in quality marketing, other managerial functions etc. The involvement of venture capitalist depends on policy framed. 

6. Exit Plan: Venture capitalists aim at making long term capital gain. A venture may exit by way of Initial public offerings (IPO’s), acquisition by another company etc.

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