How Do Private Funds Provide Capital?

A fund is an entity created to pool money from multiple investors—often referred to as limited partners. Each investor makes an investment in the fund by purchasing an interest in the fund entity, and the adviser uses that money to make investments on behalf of the fund. Traditional venture funds typically invest in businesses in exchange for equity and some firms specialize in particular industries or in companies at a certain stage (for example, early, mature, or later stage).

A private investment fund is an investment company that does not solicit capital from retail investors or the general public. Members of a private investment company typically have deep knowledge of the industry as well as investments elsewhere. To be classified as a private fund, a fund must meet one of the exemptions outlined in the Investment Company Act of 1940. The 3C1 or 3C7 exemptions within the Act are frequently used to establish a fund as a private investment fund. There is an advantage to maintaining private investment fund status, as the regulatory and legal requirements are much lower than what is required for funds that are traded publicly.

The Four Main Types of Private Investors

1. Friends and Family

Friends and family are often the first private investors that startups and small businesses turn to. They’re a great resource for seed funding and startup money, as friends and family already have that base of trust and involvement that founders usually have to build from scratch with other private investors.

2. Angel investors

Angel investors are private investors that are wealthy individuals who invest in startups, usually at the early stages. Sometimes angel investors pool their money with other angel investors, forming an investor pool.

The typical angel investor is someone who’s net worth is likely in excess of $1 million or who earns over $200,000 per year. Incidentally, those look a lot like the credentials of an accredited investor.

Realize, though, that the angel investor is playing with their own money — not invested capital — so even though they may be a high net worth individual, they are private investors that are still looking at money coming out of their personal bank account.

3. Venture capitalists

Contrary to popular mythology, venture capitalists are just regular people who make bets on big opportunities like anyone would in the stock market.

One way that they’re different from “regular people,” however, is the fact that they work for venture capital firms. Unlike angel investors, they are private investors that are not investing their own money, but rather the money of their employer. They do everything in their power to make sure their bets pay off, but ultimately, even the best ones miss far more often than they hit.

A venture capitalist is charged with finding a relatively small number of investments (usually less than a dozen per year) to make over a seven to 10 year period. While the venture capital firm may look at thousands of deals in a given year, they can only pick a handful of deals to pursue.

4. Private equity firms

Unlike just about every other type of capital, private equity isn’t really associated with startup capital – it’s associated with growth capital. Private equity is a type of investment typically reserved for companies that have already grown to a larger size and are looking for a particular growth or exit strategy that isn’t available through traditional financing.

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