Venture Capital - Explained
What is Venture Capital?
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Table of ContentsWhat is Venture Capital?How Does Venture Capital Work? History of Venture Capital The process followed in venture capital investmentAcademic Research on Venture Capital
What is Venture Capital?
-- See also, Venture Capital Investment New and emerging startup companies and small businesses require capital to develop their businesses. Venture Capitalists identify the technologies, products, concept or business ideas that have long term growth potential. They invest in such companies in exchange for partial ownership of the company.
Most often the venture capitalists are firm who invest in startups or small businesses. Individuals who invest in venture capital are commonly known as an angel investor. Angel investors often get involved earlier and take a smaller stake. Venture Capitalists typically take an equity or ownership stake in exchange for their investment.
Venture Capital is also known as risk capital, due to the risk factors attached to it. These investments are risky because there is very little certainty in the startup business, but at the same time, it has the potential to earn a huge return if the startup succeeds.
How Does Venture Capital Work?
Typically, the venture capital investment rounds occur after an initial seed funding. The first round of institutional venture capital investment is called a Series A round. In this process, large ownership chunks of a company are created and sold to the investors through independent limited partnerships established by venture capital firms.
Venture Capitalists invest in a promising company in the interest of generating a return through an eventual "exit" event. The exit event may come through an Initial Public Offering where the company sells its share to the public for the first time or it can be done through a merger and acquisition. The exit may also be done via the private equity secondary market. One of the main differences between venture capital and other private equity deals lies in the fact that venture capital focuses on emerging small companies in need of significant funding for the first time, while private equity typically funds larger and more established companies.
The process followed in venture capital investment
The company seeking funding through venture capital investment need to submit a business plan to a venture capital firm or to an angel investor. The venture capitalist then reviews the business plan to estimate the growth potential of the business. If they find the business plan, they perform due diligence which includes a thorough investigation of the background of the company and its management, its operating history, product or service it offers, the business model it follows and others.
Performing due diligence is a must for all venture capitalist and is very important before making any decision. Generally, venture capitalists concentrate on a particular industry and gather thorough information and knowledge about the industry. After the background check if the investor is satisfied with the finding they may agree to invest capital in the company in exchange for equity. The venture capitalist may invest the whole amount at once, or it may provide the capital in rounds.
The venture capitalists or angel investors may become a part of the board of directors or assumes a consulting role within the business. The aim is to keep a close watch on the business and its growth. They often take an active role in the company's business and creates a positive impact on the growth trajectory of the business. The venture capitalist or angel investor exit the company after a certain time either by initiating a merger and acquisition or by initial public offering.
Typically, the venture investors take four to six years before exiting a company in which they have invested in. Although apparently, it seems that raising venture capital investment is quite common, the truth is, historically less than 1% of businesses have been successful in securing a venture capital investment. According to Harvard Business School Review, venture capital investment is the exception, not the rule.
The PitchBook-NVCA Venture Monitor reports, by the end of 2018, the venture industry deployed $130.9 billion in US-based startups. It surpassed the all-time high in 2000. The report observes the late-stage financing has become more popular among venture capitalist firms, as they prefer less-risky ventures.
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