Glossary · Asset class
Venture Capital (VC)
Also called: venture investing
Venture capital (VC) is equity financing for young, high-growth private companies, usually provided through closed-end funds in exchange for minority stakes, with fund returns driven by a small number of very large exits.
A venture capital firm raises money from institutions and wealthy individuals into a fund and buys minority stakes in startups that could become very large. Most of those companies fail or return little; a few return many times the money invested and pay for the rest. Investors are paid back only when companies are sold or listed, usually many years after the first investment.
Formal definition
US securities law defines a "venture capital fund" only for one purpose: the venture capital fund adviser exemption from registration with the Securities and Exchange Commission (SEC). Under Rule 203(l)-1 under the Investment Advisers Act of 1940, it is a private fund that (1) represents to investors that it pursues a venture capital strategy; (2) immediately after acquiring any asset other than a qualifying investment or short-term holding, holds no more than 20% of its aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments, valued at cost or fair value, consistently applied; (3) does not borrow or incur leverage above 15% of contributions and uncalled commitments, and then only for a non-renewable term of no more than 120 calendar days (a guarantee of a qualifying portfolio company's obligations up to the value of the fund's investment in it is not subject to the 120-day limit); (4) does not offer redemption rights except in extraordinary circumstances; and (5) is not registered under the Investment Company Act and has not elected to be a business development company. Qualifying investments are, in essence, equity securities acquired directly from a company that, when the fund invests, is neither a public reporting company nor foreign-traded and is not under common control with such a company, is not itself an investment company, private fund or commodity pool, and does not borrow in connection with the fund's investment and distribute the proceeds to the fund in exchange for that investment.
How a venture capital fund works
Most venture capital is managed through closed-end limited partnerships. A general partner raises capital commitments from limited partners (pensions, endowments, foundations, family offices, funds of funds, wealthy individuals), calls that capital over an investment period, and charges a management fee and carried interest. The fund buys minority positions in private companies across one or more financing rounds, usually as preferred stock in priced rounds or through SAFEs and convertible notes at the earliest stages. Cash comes back only on exits: trade sales, IPOs, or secondary sales of shares. Board seats normally go to the investor that leads a round, not to every investor in it.
Skewed returns and what follows from them
Venture outcomes are highly skewed. Kerr, Nanda and Rhodes-Kropf (Journal of Economic Perspectives, 2014) describe the probabilities of success in entrepreneurship as low, extremely skewed and unknowable until an investment is made. In a venture fund, a minority of companies produces most of the proceeds, and many investments return less than cost. That shape drives how venture funds are built: managers target meaningful ownership in each company, keep follow-on reserves to defend ownership in the companies that work, and size positions so that a single success can return the fund (see venture portfolio construction). It also means that the median fund and the average fund tell different stories, and that the gap between strong and weak managers is wide. Results also vary by period: a study of US funds using Burgiss data (Harris, Jenkinson and Kaplan, 2014) found that venture funds outperformed public equities in the 1990s and underperformed them in the 2000s.
Stages
Companies raise venture capital in rounds with conventional labels: pre-seed, seed, Series A, Series B and Series C and later. The labels describe the company's progress and the type of investor, not a legal category, and the same label covers very different round sizes across markets and years. Funds are usually stage-focused; multi-stage platforms that invest from seed to pre-IPO are a subset.
Venture capital in an LP portfolio
For limited partners, venture is a long-duration, illiquid exposure with a deep J-curve: fees and losses show up early, gains late. Interim performance (TVPI, IRR) depends heavily on unrealised marks, which are anchored to recent financing rounds and can move sharply when rounds reprice; DPI shows what has actually been returned. Because outcomes are so dispersed, LPs spend most of their diligence on manager selection and access, spread commitments across vintages, and read early performance with caution.
Regulatory treatment of venture advisers (US)
An adviser that advises solely "venture capital funds" as defined in Rule 203(l)-1 is exempt from SEC registration but is an exempt reporting adviser: it files reports with the SEC on Form ADV. Funds themselves are not "registered"; they rely on exclusions from the Investment Company Act, usually section 3(c)(1) or section 3(c)(7). Section 3(c)(1) normally limits a fund to 100 beneficial owners, but a "qualifying venture capital fund" (a venture capital fund under Rule 203(l)-1 with no more than $12 million of capital contributions and uncalled commitments, the inflation-adjusted cap in force since 30 September 2024) may have up to 250. The 20% basket is tested immediately after each acquisition of a non-qualifying asset (Rule 203(l)-1(a)(2)), so a fund that makes such an acquisition taking it above the basket, or that borrows beyond the leverage limits, does not meet the definition, and its adviser would then need another exemption or registration.
Venture capital and private equity
In broad usage venture capital is a segment of private equity; in practice the two are run differently. Buyout funds take control, use acquisition debt and underwrite existing cash flows. Venture funds take minority stakes, use little or no leverage, and back companies that are often loss-making and whose value depends on future growth. Growth equity sits between them: minority stakes in companies that already have substantial revenue.
Not the same as
- Private Equity (PE): Buyout private equity acquires control of established companies with leverage; venture capital buys unlevered minority stakes in young companies.
- Growth Equity: Growth equity funds later-stage companies with proven revenue, often profitable, and relies less on a few extreme outcomes.
- Venture Debt: Venture debt is a loan to a venture-backed company, usually with warrants; it is repaid in cash and does not depend on an exit.
- Corporate Venture Capital: Corporate venture capital is invested from a company's balance sheet, often with strategic aims, rather than from a third-party fund.
Common mistakes
- Treating the post-money valuation of a company's latest round as the value of every share, including common and junior preferred.
- Assuming every venture investor gets a board seat. Board seats usually go to round leads.
- Filing a venture capital fund under allocator types. A VC fund is a manager's investment vehicle that receives allocations; its LPs are the allocators.
- Describing venture funds as "SEC-registered". Private funds are not registered; many venture advisers are exempt reporting advisers rather than registered advisers.
- Comparing the TVPI of a three-year-old venture fund with that of a mature fund.
- Treating stage labels as standardised definitions.
Edge cases
- Shares a fund bought before a portfolio company's IPO stay qualifying investments, because the Rule 203(l)-1 company test applies when the fund invests; shares a crossover fund buys after listing, or buys from other holders, count against the 20% non-qualifying basket.
- Venture secondaries funds buy existing fund interests or company shares from other holders; they are venture exposure but not primary venture capital.
- Venture studios build companies internally and take founder-like ownership, which fits neither the fund nor the angel model cleanly.
Questions
Is venture capital a type of private equity?
In broad usage, yes: it is private equity investment in young companies. In practice it differs from buyouts in control, leverage and the type of company backed, so most LPs treat it as its own allocation.
Do venture capital firms have to register with the SEC?
Not if they advise only venture capital funds as defined in Rule 203(l)-1. Such advisers are exempt from registration but report to the SEC as exempt reporting advisers.
How do venture capital funds make money?
From the difference between what they pay for shares and what they receive when companies are sold or listed. The manager earns a management fee and a share of profits (carried interest).
External standards
| Standard | Relation | Note |
|---|---|---|
| SEC Investment Advisers Act Rule 203(l)-1 (17 CFR 275.203(l)-1, definition of venture capital fund) | narrower | Regulatory definition used only for the venture capital fund adviser exemption; market usage is broader. |
Sources
- 17 CFR 275.203(l)-1 - Venture capital fund defined. U.S. Securities and Exchange Commission (CFR text via eCFR; LII mirror), eCFR current as of 2026-09-29; last amended 2018-03-12. Status: in force (checked 2026-10-01). 17 CFR 275.203(l)-1(a)(1)-(5), (c)(3), (c)(4)(i)-(iii) — supports: Regulatory definition of venture capital fund: strategy representation, 20% non-qualifying basket, 15% / 120-day leverage limit (portfolio-company guarantee exception), no ordinary redemption rights, not a registered fund or BDC; qualifying investment and qualifying portfolio company conditions
- 15 U.S.C. 80b-3 - Registration of investment advisers (Advisers Act sec. 203, incl. 203(l) and 203(m)). U.S. Congress (United States Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Advisers Act sec. 203(l)(1) — supports: Exemption from registration for advisers solely to venture capital funds
- 17 CFR 275.204-4 - Reporting by exempt reporting advisers. U.S. Securities and Exchange Commission (CFR text via eCFR; LII mirror), eCFR current as of 2026-09-29; no substantive amendment since eCFR baseline. Status: in force (checked 2026-10-01). 17 CFR 275.204-4(a) — supports: Exempt reporting advisers relying on 203(l) report on Form ADV
- 15 U.S.C. 80a-3 - Definition of investment company (Investment Company Act sec. 3, incl. 3(c)(1) and 3(c)(7)). U.S. Congress (United States Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). ICA sec. 3(c)(1), 3(c)(1)(C)(i), 3(c)(7)(A) — supports: 100-holder exclusion, 250-holder qualifying venture capital fund variant (statutory $10m, indexed by the SEC), 3(c)(7)
- 17 CFR 270.3c-7 - Inflation-adjusted definition of qualifying venture capital fund. U.S. Securities and Exchange Commission (CFR text via eCFR; LII mirror), Adopted 89 FR 70479 (2024-08-30); effective 2024-09-30. Status: in force (checked 2026-10-01). 17 CFR 270.3c-7(a)-(b) (89 FR 70483, effective 2024-09-30) — supports: $12,000,000 inflation-adjusted cap for qualifying venture capital funds, effective 2024-09-30; next adjustment on or about 1 November 2029
- Private Equity Performance: What Do We Know?. Robert S. Harris; Tim Jenkinson; Steven N. Kaplan, The Journal of Finance, Vol. 69(5), pp. 1851-1882. Status: Published (paywalled) (checked 2026-10-01). Abstract — supports: US venture funds outperformed public equities in the 1990s and underperformed in the 2000s
- Entrepreneurship as Experimentation. William R. Kerr; Ramana Nanda; Matthew Rhodes-Kropf, American Economic Association (Journal of Economic Perspectives), Journal of Economic Perspectives 28(3), Summer 2014, pp. 25-48. Status: published (checked 2026-10-01). Abstract — supports: Low, skewed and unknowable success probabilities