If you’re a founder considering venture capital, stop thinking of VCs as mystical “investors” and start thinking of them as business owners. They’re running their own company, it just happens that their business involves selecting startups to fund with the goal of making significantly more money in return.

So why are they talking to you at all? We’ll come back to that crucial question.

First, let’s demystify what a “VC” actually is by following the money. This explanation focuses on the UK system, but the fundamental principles apply globally.

The business behind Venture Capital Link to heading

When VCs talk about their “fund,” they’re referring to a legal partnership between two key groups:

Limited Partners (LPs) - These are the real money behind the scenes. Think pension funds, wealthy individuals, family offices, and institutional investors. They provide the capital but stay hands-off. And legally speaking their liability is limited, hence LP. Which in practice means they can only lose what they put in, nothing more.

General Partners (GPs) - These are the VC firm partners whose faces you see on websites. They manage the fund and make investment decisions according to rules agreed with the LPs. And in return for that executive power, they are liable for all the costs the fund incurs, regardless of how much capital they personally put in. Technically a GP is usually a limited liability company in its own right, so that the personal loss of the individuals is protected, but that’s getting too far in the weeds.

To handle the day-to-day investment work, GPs set up a separate management company. This company finds and manages investments for the partnership, or more than one of those partnerships. Since investment management is regulated activity they must also comply with financial regulations (in the UK, that’s set by the FCA, in the US that’s the SEC and state specific legislature).

How VCs make money: The “2 and 20” model Link to heading

Like any business, the VC management company has operating costs. Nothing exceptional, things like email, office, basic salaries, saas subscriptions, accountants & lawyers, etc. To cover these, they charge the fund 2% annually of the total fund size.

Example: If LPs have invested £10 million in a fund, the management company takes £200,000 per year—regardless of investment performance. This isn’t profit; it’s just the cost of keeping the lights on for the management company.

The real money comes from successful investments. VCs typically receive 20% of the gains they create, but only after investors get their original money back (and sometimes a minimum return on top). This profit share is called “the carry”.

Averages & Homeruns Link to heading

Venture capital is intentionally high-risk, high-reward. Here’s what a typical early-stage startup portfolio looks like:

50-60% will fail completely or sell for pennies
20-30% will have modest exits (breaking even or returning 2-3x the investment)
10-20% will be potential home runs, i.e. investments that alone pay back the entire fund

VCs fundamentally expect more than half of their investments to fail, a few to break even, and are banking on 1-2 massive successes to make the entire fund profitable. And that’s a scenario for a talented VC!

What does this mean for your business? Well bluntly:

Being an average business simply doesn’t work for the VC model

Even if, as a founder, an average business with an average exit could make a meaningful difference to your personal life. The VC model simply can’t survive on those.

Let me illustrate this point with some back of the envelope math on a fund with £10 million of capital available from LPs:

Management fees: £200,000 × 10 years = £2 million
perating costs: Legal, accounting, other services over 10 years = £1 million
Available for investment: £7 million remaining
If you invested in 20 companies equally, £350,000 each, that means a homerun needs to return 28x the investment. (28 x 350,000 is 9.8 million).

Spread the risk more by investing in more companies means a homerun requires an even higher return multiple.

On the other hand, concentrate the risk more by investing a larger amount in fewer companies, and the bar for homerun lowers but you get less at bats, so to speak. That’s the balance a VC tries to manage.

What this means for you as a founder Link to heading

Now we can come back to that opening question: Why are they talking to you?

VCs are looking for that single company that can return their entire fund, and then some. This directly shapes how they evaluate your startup:

They need massive exits: Small wins don’t move the needle. Early-stage VCs typically need to see potential for 30x+ returns on their investment.
Their compensation depends on your success: Most of a VC’s income comes from carry, so they’re personally incentivized to help you succeed big. Remember, carry only comes in when they have paid back the original investors in the fund.
They have strict criteria: Their mandate from LPs limits what they can invest in, creating seemingly arbitrary rules about sectors, geography, or business models that rules out your business regardless how great it might be.

So far I talked about a modest investment, a few £100k, which in the UK is a typical amount at seed stage. And, let’s say we’re targeting a 20% ownership stake for the VC. So your business is valued at about 1.5m. A 28x exit, would mean somewhere in a few years your business is valued at £40-£45m.

Now change that investment from £350k to £10m, with the same ownership dynamics. Your business is now initially valued at £50m. And you need to become a £1.4 billion company to justify the VC equation. So not just a unicorn, but a unicorn and then some. Do you have that in you?

Ever wonder why VCs obsess over your “total addressable market”? Now you know. They need to invest in businesses that could theoretically grow large enough to justify realistic prospects of a huge exit.

It’s not just about having a good idea—it’s about having a good idea at the right time in the right market. VCs naturally gravitate toward the biggest growing trends not because they’re chasing hype, but because they’re stacking the odds in their favor for the kind of valuations they need in 5-10 years time.

And finally it’s about you, the founder(s) Link to heading

Assuming you’re building something in a massive, growing market, the remaining question is whether you can execute at scale. VCs are evaluating:

Can you navigate the journey from startup to billion-dollar company?
How will you behave when things get tough?
Do you have the credentials and experience to sell this vision?
How far can you personally take this before you need to step aside?

Understanding VC math changes how you approach fundraising. VCs aren’t being unreasonable when they ask about massive market opportunities or 10x growth potential—these requirements are baked into their business model.

If you can’t envision your company reaching those valuations, venture capital might not be the right funding path. But if you can, now you understand exactly what VCs are looking for and why.

Bonus: VC Jargon Buster Link to heading

Venture capital comes with its own language, so here’s a quick, founder-friendly guide to the jargon you’ll hear in every funding conversation.

GP/LP: a partnership between limited partners (investors in the fund) and general partners (VC, managing the fund). The basic structure of most VC funds.
2 & 20: the fee structure most VC operate on. The fund pays 2% per year in management costs to the VC to operate their business. The VC is incentivized by getting 20% of the profits once investors have their initial money back. Even if these days management fees might be a little lower, 2&20 is still the phrase that’s used.
Carry: another word for the 20%. That 20% is then split inside the VC firm according to their own rules, often seniority based.
Carry vehicle / Carry partnership: The way the VC receive their 20% is typically through a separate entity (the carry partnership) which is an LP in the GP/LP structure. Complications mainly for tax reasons.
Term Sheet: the document outlining the key elements of the deal between you and the VC. It’s not a binding contract, but definitely a statement of intent.
Down round: a round of fundraising where your company is valued lower than the last time you raised.
Dilution: “raising money” really means letting someone buy new shares in your company. And as a result people with existing shares will therefore own a little less of the pie.
Anti-Dilution: the mechanics get complex, but sometimes investors will have terms that protect their share of the pie; typically these only activate in down rounds.
Liquidation preference (commonly referred to as “pref”): a common way for VC to protect their investment by setting a minimum hurdle rate (1 or more times initial investment usually). This hurdle is paid out before other investors get paid. As a founder, you are usually in the “other investors” category.

note Link to heading

I wrote this post originally as a guest post for the team at Collectively Better, who I work with from time to time advising early stage companies in their portfolio.