Understanding How Venture Capital Works for Startups
- Erdinc Ekinci
- 4 days ago
- 5 min read
Venture Capital (VC) is often seen as the “golden ticket” for startup founders. If you raise VC, it feels like you’ve made it—it’s a big milestone that many startups chase. But here’s the truth: Venture capital is not a trophy. It’s a tool. And like any tool, if you don’t know how to use it properly, it can cause more harm than good.
In our session, “Understanding How Venture Capital Works for Startups,” I shared the real story behind VC—the stuff you won’t hear in pitch competitions or read in news headlines. We discussed how venture capital funds operate, how investors think, and why raising money can be just as risky for founders as it is exciting.
This blog is your deep-dive summary—no sugarcoating, no hype. Just honest insights every founder should understand before jumping into the VC game.
🎥 Watch the full session here:
1. Venture Capital Is Not Free Money
Many people think venture capital is like a prize or donation, but it’s not. VC firms manage money that comes from other people, called Limited Partners (LPs). LPs can be pension funds, wealthy individuals, or large institutions. VCs invest this money into startups with the goal of making big returns, usually over a 10-year timeline.
If you take VC money, you’re agreeing to try and grow fast, take big risks, and aim for a big exit — like an acquisition or IPO.
Key Points:
VC firms invest in exchange for equity, typically 10–25% per round.
They expect high growth and big returns — not just survival.
The funding is meant to be used quickly to build, grow, and gain market share.
2. Not Every Startup Should Raise VC
One of the biggest mistakes founders make is assuming that every startup should raise venture capital. But not all businesses are a good fit.
VCs are looking for companies that can grow fast and return 10 to 100 times the money they invest. That usually means startups with a huge market, global potential, and strong user growth. If your business is a local shop, a service business, or a small-scale tool, it might be great — just not the kind of business VCs invest in.
Key Points:
Less than 0.5% of startups raise VC funding.
VCs want businesses that can scale quickly and massively.
Local or slow-growth businesses are often better off with other types of funding like bootstrapping or small business loans.
3. Bootstrapping is a Valid and Powerful Option
Bootstrapping means growing your startup using your own money, revenue, or savings. Some of the most successful companies, like Mailchimp and Basecamp, never took outside funding.
Bootstrapping gives you freedom. You can focus on your product, take your time, and stay true to your vision without pressure from investors.
Key Points:
You keep full ownership and control of your company.
VC-backed companies may grow faster, but they give up more control.
Choose the path that matches your long-term goals.
4. The “2 & 20” Model: How VCs Make Money
Understanding how VC firms make money can help you understand their motivations. VCs usually follow a model called “2 & 20.” This means they earn:
2% of the fund’s size every year as a management fee. For a $100 million fund, that’s $2 million per year for salaries and operations.
20% of the profits (called “carried interest”) from successful investments. So if a $1 million investment turns into $10 million, the profit is $9 million — and the VC takes $1.8 million.
This model rewards big wins. That’s why VCs are always looking for startups that can grow 10x or more — even if it means most of their portfolio fails.
5. Venture Capital Is High Risk, High Reward
VCs don’t expect every startup to succeed. In fact, they plan for most to fail. Their strategy relies on one or two outliers making huge returns to make up for the losses.
Typical Portfolio Outcomes:
Around 60% of startups fail and return nothing.
About 35% may break even or give small returns (1x–2x).
Fewer than 5% are outliers — returning 10x or more and driving the whole fund’s success.
As a founder, this means taking VC money comes with big expectations. You’re not just expected to grow — you’re expected to win big.
6. Fundraising Is a Skill Every Founder Can Learn
In the early stages, investors are betting more on the founder than the product. That’s why your ability to communicate, build trust, and pitch with clarity is crucial.
VCs look for:
Grit — the ability to keep going through tough times.
Coachability — being open to learning and adjusting.
Vision — a clear plan and belief in the future of your business.
Fundraising is a learned skill. You can improve with practice, mentorship, and preparation. The best founders know how to build long-term relationships with investors, handle rejection, and tell a compelling story.
7. Convertible Notes and SAFEs: Early-Stage Tools
When you're just starting out, it can be hard to put a value on your company. That’s why many early-stage startups use instruments like convertible notes and SAFEs (Simple Agreements for Future Equity).
These tools let you raise money now and decide on valuation later — often during a future funding round.
Key Differences:
Convertible Notes are loans that convert to equity later. They usually include interest, a maturity date, and sometimes a valuation cap.
SAFEs are simpler and more founder-friendly. They don’t have interest or maturity dates.
Before you sign any deal, understand the terms clearly — especially rights, preferences, and ownership implications.
8. Fundraising in Japan: What’s Different?
If you’re raising money in Japan, the process may feel slower or more formal than in places like Silicon Valley.
Japanese VCs tend to be cautious and relationship-driven. They often look for strong traction in the local market before backing international expansion. But once you earn their trust, they can become long-term partners.
Key Points:
Japanese VCs value structure, due diligence, and long-term stability.
Smaller round sizes and slower decision-making are common.
If you're aiming for global markets, consider both local and international investors.
Final Thought: VC is a Choice — Not a Must
Venture Capital is not a sign of success by itself. It’s a tool — one that can help you grow quickly if your startup is ready for that kind of journey.
Before you raise:
Ask yourself if you want to grow fast and aim for a big exit.
Consider how much control you’re willing to give up.
Make sure your vision, product, and team are aligned with investor expectations.
If the answer is yes, VC can be rocket fuel. If not, there are many other ways to build a successful company. If you’re exploring your funding options and want to learn more, check out the full video!
We also have an upcoming event, Understanding how VC works For Startups @Tib on June 13th,2025. If you are interested, join us from 6 pm to 8 pm JST and learn the business model of VCs with the all secrets in a friendly environment so you can raise better!
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