What Is Venture Capital?

What Is Venture Capital?

Venture capital (VC) is a form of private financing that provides funding to startups with high growth potential. VC can be advantageous to new businesses that do not qualify to get traditional bank loans. The money deployed by venture capital firms usually comes from institutional investors, corporations, or wealthy individuals looking to make some serious returns. Beyond just monetary support, VC can also offer:

  • Managerial or technical expertise
  • Informal financing such as “love money” that are friends and family members to the business
  • Added connections that the investors bring to the table

Venture Capital Explained

Venture capital can be referred to as a type of private equity investment. Investors, whether firms or individuals, fund new companies in return for equity, making them shareholders with influence in decision-making. In exchange, investors receive equity in the company as shareholders they can contribute to the decision-making process. Later, they can leave the company – either via selling off their stake or when a company offers IPOs (initial public offering).

The main idea behind VC is that the firms or individuals who invest in start-ups, have eyes the payoff down the line if the company succeeds. Venture capital is not a loan because companies do not make monthly payments to the investors.  Instead, venture capitalists are paid in the form of equity shares in the company.

Financial returns for venture capitalists materialize when the startup goes public or is acquired, making the investment horizon longer than traditional stocks or mutual funds. That means venture capital takes a longer time to generate a return on investment as compared to investing in a stock or mutual funds.

Why invest?

The main advantage of investing in VC is to reap big financial returns if the company starts to do well. For instance, if a start-up manages a successful IPO, the value of the investor’s equity share could skyrocket overnight. If an investor sells the shares, the end result could be substantial profit and return on initial capital investment.

Similar to VC, alternative investments like cryptocurrencies, particularly Bitcoin, can also offer substantial returns. Read our latest article to understand the benefits of Bitcoin investment.

Furthermore, VC allows investors to support and shape businesses with transformative potential. By holding equity, they play a role in decision-making, pooling expertise and resources to foster growth. It is a chance for them to show care for business that has the potential to change the world. By having a share of equity in the company, venture capitalists also become part of the decision making and management. In this way, they work together for bringing in better expertise and resources in the business.

 

The venture capital process

Startups begin by submitting their business plan to a VC firm. If deemed promising, the firm conducts due diligence, evaluating the company’s management, products, and business model.

Ensuring the startup’s viability is crucial since VCs invest significant sums. Once the due diligence is completed, the investor will then pledge an initial capital in exchange for equity in the business. The capital may be provided all at once but normally businesses are funded in rounds. The venture capital then actively participates in the funded company to advise and monitor the progress before releasing additional funds.

Investor exists the company typically after four to six years after the initial investment either by initiating an IPO, merger, or acquisition.

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