Most venture capital funds are so-called life-cycle funds. This means that it is clear from the outset how long the fund will be active and when it will become inactive. There are certain parallels to a start-up in that a VC fund is also dependent on (external) investors, as it initially does not make any profits. This is mainly due to the fact that the companies VC funds invest in are not yet profitable themselves. Thus no dividends can be paid to the shareholders, i.e. founders and investors, from company profits. A VC fund, like other investors, makes money when its companies experience positive development and it is able to sell its investment for a higher price at a later stage.
A fund can therefore be divided into three (in some cases only two) phases: investment, development and divestment. What happens in each phase is basically self-explanatory. In the investment phase, money is secured from the fund investors and invested in young, promising companies. The companies, in turn, invest the new funds in development, testing, distribution and so forth. When the fund has reached its target for new investments, it is in the development or holding phase. This is where the portfolio companies should develop positively and create value, with the help of investors and a network. In the final divestment or exit phase, the investments are then sold in a way that is economically viable.
The aim of every fund is, of course, to sell as many investments for profit over its term. If this is accomplished, the fund can be closed or liquidated. Sometimes, investments made early develop well above average or quicker, and investors and founders decide to target an exit earlier than planned. In other instances, investments cannot be divested at the end of the fund’s term and so all the parties involved try to find a workable solution. Unfortunately, there are also investments that are lost during the term of the fund, as developments do not proceed as planned and the companies go bankrupt.
The typical term of a VC fund is 10 to 12 years. Since only inventory investments can be made from the middle of the term onwards (money is usually set aside for this), most VC companies try to launch the next generation of funds at this point. In the case of consecutive funds, the term duration overlaps by about 50%.