Why does a venture capital investor sometimes turn down a company that has paying customers and a promising product? How do some startups manage to raise millions before they have figured out how to make money? Why can a company that is doing reasonably well still find itself in serious trouble because it cannot raise another round? Why do experienced angels and advisers sometimes give founders advice that in retrospect did not make sense?
This guide is my answer to those questions. I wrote it for founders and for the people who advise and fund them, because in my experience very few people in the startup ecosystem, experienced ones included, understand what venture money commits a company to, or how much the model is changing.
I count myself among them. When Tørn raised its seed round in 2021, the advice that came with the money was to stop being cautious and hire and spend speedily, and I followed it. At the time I did not understand the model behind the money well enough to see what it would ask of us. Ultimately the fault was ours, but in aftermath I should have understood the model our company was becoming a part of.
What is changing makes this more urgent. Capital is crowding into fewer and bigger bets and exits are taking longer, so the gap between what founders expect from venture money and what it can deliver keeps growing.
If you know a founder who is about to raise, send this to her before she signs. If you work with founders, I hope you will pass it on to every one of them.
Let us start with the basics: how a venture fund makes money.
1. How does a VC actually make money?
Everyone knows how a bank works. A bank lends money and expects to be paid back with interest. A venture capital investor buys a share of the company instead, and makes money if the company becomes more valuable and that share can eventually be sold.
The sale happens when the company is bought or listed on the stock exchange, or when the investor sells its shares to another investor. In the venture world this is called an exit, and it is how the fund turns its investment into cash it can return to the people who invested in the fund.
There is an important detail here. Most VCs do not invest their own money the way a founder invests her time or savings. They manage money on behalf of other professional investors, called limited partners or LPs, such as pension funds, insurance companies, endowments and family offices. The LPs commit money to a venture fund, which is managed by a team of investment professionals called the general partner, or GP. The GP decides which companies to invest in and how much, including whether to put more money into them in later funding rounds.
The fund itself has a limited lifespan, commonly ten years, sometimes seven years and sometimes more. In that time it needs to invest in companies, help them grow and then sell its shares so that money can be returned to the LPs. This is quite different from owning a business for the long term. A family-owned industrial company might be happy to own a profitable business for thirty years, while a venture fund has investors waiting for their money back.
The people running the fund make money in two ways.
The first is a management fee, commonly around 2 per cent of the fund’s committed capital per year, although the rate and the way it is calculated vary. The fee pays for running the investment business, from salaries and legal costs to the work of finding, assessing and managing investments.
The second is carried interest, or carry. This is the GP’s share of the profits the fund generates, commonly 20 per cent, subject to the fund’s own terms and distribution rules.
A simplified example shows how it works. Imagine a VC firm raises a fund of 1 billion kroner and, over the life of the fund, invests in a number of startups. Some fail, and a few may generate substantial returns. Suppose the fund eventually returns 2 billion kroner, a profit of 1 billion kroner, at the end of the fund´s life. With 20 per cent carry, and once the conditions for paying carry have been met, the GP could receive 200 million kroner. The rest of the profit goes to the LPs, on top of the return of their original capital. The actual calculation depends on the fund agreement, including whether the LPs must first receive their invested capital back.
This structure has another consequence for founders. A GP manages a portfolio, with investments across many companies and sometimes across several funds. The partners have to find and assess new companies, negotiate deals, monitor existing investments, help with follow-on financing and work towards exits, and their time is limited.
Some GPs take board seats in their portfolio companies, and some are closely involved in strategic decisions, fundraising or recruitment. The level of involvement varies between funds, stages and individual partners. Founders should therefore not assume that their investor will be available to work alongside them every week. The GP’s first responsibility is the fund and its portfolio, while the founder and management team remain responsible for running the company. A board seat can bring strategic input and a network, yet an investor on the board is neither an additional executive nor a co-founder.
2. What do the investors in a VC fund expect?
An LP commits money to a venture fund because it expects a return that compensates for the risk. Venture capital is a high-risk investment: the money is tied up for years, the LPs have little control over individual investment decisions, and many of the companies in a fund will fail. In return, LPs expect the possibility of much higher returns than they could get from safer investments in other places.
A venture fund might target a net annual return of 15 to 25 per cent, depending on its strategy, stage and risk profile . Some funds express the ambition as returning around three times the money invested over the life of the fund. These are targets, and many funds do not reach them.
Gross returns describe the performance of the investments before fees and carry. Net returns are what remains for the LPs after those costs.
This matters to a founder because the fund’s return expectations decide what kind of companies it needs to invest in.
Imagine a fund that invests in twenty companies. Several may fail completely, and others may return the money invested or a modest profit. One or two exceptional companies can make the difference between a fund that performs poorly and one that delivers what its investors expect. This is called the power law: a small number of investments account for most of the returns.
It means that a company can be a good business and still be a poor investment for a venture fund. A company that becomes profitable, employs people, serves its customers well and generates reliable cash flow may be a perfectly successful business. If it cannot grow large enough to produce a sufficiently large return for the fund, the VC will not be interested. The investor is asking whether the company can become a large enough outcome for the fund, which is a different question from whether it can become a good business.
3. What makes a company interesting to a VC?
Once you understand the fund’s need for exceptional returns, the criteria VCs use to assess companies start to make sense. There are three fundamental questions.
First, is the opportunity large enough?
A company needs to address a market that can support a very large business. A great product in a small market may become a profitable company without generating the return a venture fund needs. This is why investors spend so much time on market size and growth potential: how many customers the company could eventually serve, how much they might spend and whether the business can expand beyond its first market.
A founder may see a market that offers a good opportunity to build a sustainable company, while a VC looks at the same market and concludes that it is too small. Both can be right, because they are asking different questions.
Second, can the opportunity be realised within the fund’s time horizon?
A large market is not enough on its own. The company needs a credible path to capturing a meaningful part of it within a timeframe that suits the fund. A business that takes fifteen or twenty years to mature may attract a long-term owner, and it is less attractive to a fund that must return money to its investors much sooner. The model therefore favours companies that can grow quickly and increase their value substantially in a short time.
Third, can the team execute at the required speed and scale?
The team needs to be able to turn the opportunity into a large business, which means developing the product, attracting talent, acquiring customers and making decisions quickly. The company also needs to be able to use the money it raises. A fund that invests a large amount expects that capital to drive growth, so there has to be a credible plan for putting it to work.
The three questions depend on each other, and a company that falls short on any one of them does not fit the model.
4. How do you recognise an outlier before it becomes one?
At the early stages it is very hard to tell a company that could become an exceptional outcome from one that could become a good, sustainable business. Both may have a capable and ambitious founding team, an interesting product, early customer interest and a large market on paper, and both may tell a convincing story about how the business could grow. None of this shows how large the company can actually become.
The more revealing proof emerges over time. Are customers drawn to the product, or simply curious? Do they come back, and are they willing to pay more? Can the company acquire customers repeatedly and at a sustainable cost? Does the business become more efficient as it grows, and can it expand into new markets without losing the economics that made it attractive in the first place?
These patterns become visible through execution and learning, and a pitch deck or a handful of early customer interviews cannot establish them.
This creates a difficult dilemma for early-stage investors. They need to identify companies with exceptional potential early enough to invest before those companies become expensive, at a time when the proof needed to tell an outlier from a good business does not yet exist. Early-stage venture investing therefore means making bets on the future with the information available, and with experience and judgement. Some investors will pick the right companies and others will not, which is inherent in investing in young companies, whoever does it.
It is still important to understand the difference between potential and proof. A company may have the potential to become enormous without having proven it. When a fund has very high return expectations, there can be pressure to treat the growth story as more certain than it is, and that pressure lasts well beyond the day the investment is made.
5. Why is the venture capital industry under pressure?
The venture model has always been built around the search for exceptional companies, and several changes are making that search harder.
One is the concentration of capital. A growing share of venture capital goes to a small number of companies, sectors and places. In the first quarter of 2026, four companies accounted for about 65 per cent of global venture capital deployed, and AI attracted close to 80 per cent of the total [CHECK: name the source, e.g. CB Insights, State of Venture Q1 2026]. Some AI companies may become extraordinarily valuable, so the investment is not misplaced. It does raise the question of how much capital is left for companies outside the areas attracting the most attention.
Another is that exits are taking longer. A fund eventually needs to sell its shares and return money to its investors. When stock markets are less receptive to new listings, buyers are cautious and companies stay private for longer, it becomes harder to turn investments into cash. A high valuation on paper does not mean the fund has made money or can return it to its LPs.
This creates pressure throughout the system. LPs want their money back so they can invest in new funds, and GPs need strong results from earlier funds to raise new ones. Both pressures land on the portfolio companies, which may need more time and more capital than anyone planned.
There is also a structural reason why the investment criteria of venture capital are hard to change, and it comes in four parts.
First, the GP’s income is tied to the fund’s performance. Management fees pay for running the fund, while carried interest rewards strong returns, so the possibility of exceptional returns is central to how the partners are paid.
Second, LPs commit their money to a particular investment strategy. A fund raised to invest in high-growth venture companies cannot decide halfway through its life to focus on smaller, profitable businesses with moderate growth.
Third, venture capital fills a particular slot in the LP’s overall portfolio. LPs accept the high risk because they want exposure to exceptional returns. A venture fund that started behaving like a traditional private equity investor would no longer serve the purpose the LP committed the money for.
Finally, judging whether a company might become a global outlier takes different skills from judging whether a business can become consistently profitable and generate reliable cash flow.
This is why venture capital cannot simply broaden its criteria and finance every kind of promising business. It is a specialised financing model, built for one kind of company.
The same criteria spread well beyond venture funds. Angels, accelerators and public funders who have no venture portfolio of their own often judge a company by whether a venture fund would back it next, and so apply the venture test to companies the model was never built for.
6. What happens to companies that take venture capital?
The expectations of the fund do not stay inside the fund. They transfer to the companies that receive the money, and this is the part founders most need to understand.
Growth becomes an expectation.
Once a company takes venture capital, it is judged by whether it is building a viable business and also by whether it is progressing towards the scale a venture-sized return requires. That suits a company with a large opportunity, and it can also push a company to grow before the business is ready. Hiring ahead of demand, entering new markets, expanding the product and increasing marketing spend can all look reasonable when the objective is rapid growth. The question a founder has to answer honestly is whether the proof supports those decisions.
The company may become dependent on raising more money.
Many venture-backed companies need several funding rounds before they become self-sustaining or reach an exit, so raising the next round can become almost as important as building the business. Founders have to show progress that fits investor expectations, frequently before the business is profitable.
The next round is never guaranteed. It depends on market conditions, investor appetite and whether the company has hit the milestones its existing investors expected. When those conditions change, the company can be left with a team and a cost base built on the assumption that more capital would come.
The cost base can grow faster than the business.
Venture funding makes it possible to hire, spend and expand before revenue catches up. Sometimes that is necessary, since a company entering a large market may need to invest ahead of demand. Investing ahead of the business is still different from committing to a growth plan that has not been proven. A growing team, more product development and new markets can create the appearance of momentum without proving that the business model works. If the assumptions behind the growth turn out to be wrong, the company is left with costs that are hard to reverse.
This is one of the patterns I explore in my book, The Avoidable Startup Failure. Companies lock themselves into decisions before they have the proof to justify them, and funding can speed that up.
Some companies end up in between.
A venture fund is making bets, and it expects many of them not to come off. A few companies in each portfolio become the large outcomes the fund was built for, and some fail and close. Many end up somewhere in between, still alive and still building, yet neither growing fast enough for the fund nor ready to stand on their own.
Few instruments exist for these companies. They will not return the fund, so the venture model has little use for them, and other kinds of capital rarely step in once a company’s costs and ownership have been shaped around a much larger outcome. Founders should know before they raise that this middle exists, and that ending up there is common.
The founder and the fund may define success differently.
A founder may want to build a durable company, create a good workplace, serve customers and generate long-term value. A fund needs to return capital to its investors within a defined period. These goals can overlap without being identical. A company that gives its founders and employees a good living may be a success from one perspective and an unsuccessful investment from the fund’s. The difference need not create conflict, as long as the founder understands it before taking the money rather than discovering it several years later.
7. What should founders ask before taking venture capital?
The useful question is whether venture capital is the right capital for the company you are trying to build. Before raising a venture round, I think founders should ask themselves some difficult questions.
Is this a venture-scale opportunity?
Is the market large enough to support the kind of company the fund needs, and is there a credible path to becoming a major player? Or are you trying to fit a sound but more limited business into a venture narrative?
What have we proven, and what are we still assuming?
What do we actually know about customer demand, pricing, repeat purchases and the cost of acquiring customers? A large market estimate is not proof of demand, and early traction is not yet proof of repeatable growth.
How much capital will we need before the business sustains itself?
A funding round is one step in a longer financing path. What happens if the next round takes longer than expected, or comes at a lower valuation than you want? How much runway will the company have, and what will it need to decide?
What happens if growth is slower than expected?
Can the company reduce costs without destroying the business, and can it reach profitability at a smaller scale? Is there a viable business if the original ambition takes longer or turns out to be too optimistic? Asking this is a matter of resilience, and there is nothing pessimistic about it.
Do we understand what our investors need from us?
What return does the fund target, and how long does it have to invest and return the money? How many companies are in its portfolio, and how much has it reserved for follow-on investments? What does it consider a successful outcome, and what happens if the company becomes a good, profitable business without becoming the large outcome everyone hoped for?
What involvement can we expect from the investor?
Will the investor take a board seat, how often will you meet, and who will be your main contact? How much time can the partner give your company? Discuss this before you sign, rather than assuming that a venture fund comes with unlimited advice and operational support.
Could another form of capital fit better?
Venture capital is one of many financing options. Depending on the business, founders might consider revenue-based financing, loans, grants, strategic or industrial investors, family offices, angels, or growing more slowly on customer revenue. Each has its own trade-offs in how much capital it offers, how fast it lets you grow and how much control or risk it involves. The point is to understand the options, and to look for capital whose terms match the company, before treating venture capital as the default.
8. Venture capital is one model of success among several
Venture capital has a clear purpose. It finances companies that can grow into very large businesses and generate exceptional returns within a fund’s lifetime, and for those companies it can be exactly the right instrument. It does not measure every kind of business value or reward every kind of success.
Many companies can become profitable, innovative, exporting businesses without ever becoming billion-kroner companies. They create jobs, develop technology and pay tax at home, and they can be excellent businesses even when no venture fund would back them. These are the bedrock companies an economy is built on, and we need to be able to recognise them as successes.
For founders, understanding the model is part of making a good financing decision, because the capital you take shapes the expectations placed on the company and the options open to you later. For investors and advisers, it matters just as much to understand what the model rewards and what happens when a company does not follow the expected path.
Every round you take puts your company on someone’s clock. Make sure you know whose.
My book is called The Avoidable Startup Failure. It is out now.