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Anyone wanting to get a primer on the venture capital business model should listen to this brief explanation by Tim Chang of Norwest Venture Partners.
Chang gave the quick hit to audience members of the San Fran Music Tech Summit last month, a gathering of musicians, technologists and other fans of the digital music business.
The bottom line for VCs, as Chang explains, is that every deal they invest in needs to hold the potential to grow in value until it equals the venture fund it is a part of.
In the trade, it's called "returning the fund."
If a VC firm owns 10% of a startup at the time of exit, whether it be an acquisition or an IPO, those deals need to provide a 2x to 4x return on the fund so there's enough profits to go around for the firm's own partners and the limited partners who invest with them, mostly big institutional investors and wealthy individuals.
According to Chang, 75% of startups die and return no money to the VCs, which is why he says his job is to not only take risk, but to manage it.
So the next time you tell a VC you want him to invest $5 million, and he only wants to give you half that, maybe you'll be able to sympathize.
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