How Do You Make Money in a Venture Capital Investment?
- Aug 4
- 7 min read
Increasingly, physicians in our online physician communities are interested in alternative investments, including real estate, angel investing, cryptocurrency, precious metals, and venture capital. While there is a lot to be said for tried and true ‘set it and forget it’ investing in the stock market, there are many reasons why doctors may want to diversify their investment portfolios. Particularly as the health tech space continues to boom, physicians have been approached by (or actively seek out) venture capitalists to invest in early stage companies or rapidly growing startups. These opportunities offer an exciting way to participate in the potential upside of companies that may have large exits, as well as a front row seat to innovation. Below, we cover what physicians should understand about how money is made in venture capital investments, how the venture capital firm makes money versus how a limited partner in a fund makes money, what risks to be aware of when investing, and more.
Disclosure/Disclaimer: Our content is for generalized educational purposes. While we try to ensure it is accurate and updated, we cannot guarantee it. We are not formal financial, legal, or tax professionals and do not provide individualized advice specific to your situation. You should consult these as appropriate and/or do your own due diligence before making decisions based on this page. To learn more, visit our disclaimers and disclosures.
How do venture capital investments work?
At the heart of venture capital is the ability to invest in companies and to make money as the value of those companies increases over time. The fact is that most startups fail. Venture capitalists understand this, so they typically carefully pick out a portfolio of companies to include in their funds that they believe have the best potential for growth, substantial and scalable revenue, and/or a potential exit (usually an acquisition or an IPO). They know that a good percentage of these companies will not make it to profitability or across the finish line with an exit, but the bet that they are taking is that a few successful investments will generate returns that are large enough to offset the losses from the investments they make in companies that do not ultimately succeed.
Most physicians who invest in venture capital do so via a fund, which is a curated pooled investment opportunity managed by a general partner(s) that makes raise capital and investment decisions.
Learn more about the life cycle of a venture capital fund.
What does it take to make money in venture capital?
Essentially, enough of the companies your portfolio invests in have to do well enough to generate profits above and beyond the companies that you invest in that create losses. These are the stages that have to happen in order for a particular investment to do well.
Buy equity in a company that fit your investment thesis
The model of venture capital investing consists of buying equity in companies at an early stage via strategic investments. When you hear that startups are raising money, they are often going to different investors, including venture capitalists, asking for money in exchange for a percentage ownership stake of the company.
As an example, a venture capital fund may invest 1 million dollars in a company raising money at a valuation of 20 million dollars. They would then own a 5% stake in the company.
Ideally, help the company grow
While not all VCs are the same in this regard, the best venture capitalists provide more than just money. They provide strategic advice, introductions, and other help to the founders of the company to help the company achieve new heights.
Make money when the company has a capital event or exit that allows for taking profit off the table
There are multiple ways in which a company can start returning money to its investors. If it has significant profits, it may be able to make money simply off of dividends being issued to shareholders, although this is rare because most venture capital backed startups are focused on growth and reinvesting the money for future benefits, rather than distributing profits. Therefore, in most cases, money from an individual investment in a company comes when there is an ‘exit’ for that company.’ An exit can be:
An acquisition of the company by another company - essentially, a larger company buys the company
An initial public offering (“IPO”) - where a company ‘goes public’ by listing on the stock exchange, putting a monetary value on the shares that can be sold
A secondary sale - occasionally, especially if a company is doing well, other investors may want shares in the company and may offer to buy the VC’s shares
Do I make money if the venture capital company makes money?
Possibly. It’s critical to understand that while your interests may be aligned in terms of the VC company wanting to pick good investments to share in the upside of these companies alongside you, that is not the only way that they make money, whereas it is likely the only way that you make money. Venture capital companies make money in two ways.
Management fees: As an investor in a VC fund, you as a limited partner (LP) have to pay a certain annual fee (often between 1-3% of your committed capital) to the fund managers (the GP, or the venture capital company) to cover operating expenses. Note that depending on the size of the fund, this amount of money may or may not be a sizeable amount of money/profit for the venture capital company. As you can imagine, 2% managing a billion dollar fund is very different from 2% managing a 1 million dollar fund.
Carried interest (the “carry”) - this is why most venture capitalists are in it, and where their interests are aligned with yours. If the fund is profitable, the VC fund typically receives a significant percentage of the profits (for example, 20%) after the investors get their investment back (+ any preferred return if applicable). So for example, if a VC company has a 20% carry, and investors invested 10 million dollars and the fund generates 100 million dollars in profit, the VC fund might get 20% of the 90 million remaining after the investors are given back their capital.
Is it worth it for a physician to quit their day job and become a venture capitalist?
Like most venture capitalists, if you are a physician raising a venture capital fund or on the GP side of a venture capital deal, you are likely going to be most excited about the upside that will come from companies that do well and the profit from that carry. The management fees alone may not compete with your physician salary, so the thought that physicians who have given up their day job to be venture capitalists for the fees is likely a misconception in most cases. You will likely need other cash flow or cash reserves if you want to maintain the lifestyle your physician salary afforded while you wait for the life cycle of your VC fund to play out.
How likely is it that a venture capital investment makes money?
It’s very, very important to understand that venture capital investments are risky, and that it is very possible to lose money in them (and potentially all of your money). A typical VC portfolio may have about 50-70% of the companies that fail or lose money, and the majority of the rest of the companies usually just return a modest amount that may not offset the opportunity cost of the investment. It’s the 5-10% of companies in the fund that you’re hoping will return a very large return - maybe 10-100x of your original investment, that are going to generate the returns that are ‘worth it’ as they will drive the fund’s overall return.
If you don’t have any companies that hit that home run, you may end up wishing you’d invested that money in a boring index fund instead.
An example of a venture capital fund that makes money
Let’s say your fund raised 100 million dollars and gave the venture capital company a carry of 20%. The fund may invest in 50 companies. Let’s say that after 10 years, 30 of those companies are no longer around and never generated enough money to create a profit, or were never acquired. Let’s say that 14 of them did just alright, and returned capital to the investors or a small profit. However, 6 of them were very successful and delivered large returns, making the fund now worth 300 million dollars.
If you invested $1M in this fund, you would get back your initial investment, and then your share of the profit of 200 million dollars (minus expenses and carried interest profits to the venture capital fund that deployed the capital). You’d likely make approximately 1.6M dollars in addition to your return of capital.
If you were the venture capital company, you’d make 20% of the $200M, or ~$40M dollars.
These numbers are slightly simplified, but hopefully convey the overall economics.
Conclusion
The key thing to understand here is that investing in venture capital is a portfolio game - you know that not every investment that the fund makes is going to succeed (or succeed enough to generate profit), but that you believe that there are going to be enough exceptional companies in there that generate large enough returns to make it worth it and offset the losses from the rest. If your fund happens to invest in a unicorn, you’ll be very happy, but you have to know that there’s also the possibility that you’ll never get a cent back. Understand your tolerance for losses when deciding if you want to engage in the excitement of venture capital investing!
Additional venture capital related resources for physicians
Sign up for our weekly newsletter for alerts about health innovation and venture capital related content and events, as well as our other content, including new blog articles, physician educational webinars, and member resources.
We sometimes have free virtual events on investing in VC funds. Make sure you’ve either signed up for the newsletter or join our entrepreneurship & health innovation series for alerts with event details.
Related PSG resources:
The VC Fund Life Cycle: Understanding the Stages of Venture Capital Investments
How to vet opportunities to invest in startups via venture capital
Differences in Investing in Venture Capital Funds vs. Angel Investments
Prior entrepreneurship and health innovation event recordings (accessible to PSG members only)
Our Physician Side Gigs podcast, where we regularly feature physicians and companies in the health tech ecosystem