Venture Capital is financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. Venture capital generally comes from well-off investors, investment banks and any other financial institutions. However, it does not always take just a monetary form; it can be provided in the form of technical or managerial expertise.
Though it can be risky for the investors who put up the funds, the potential for above-average returns is an attractive payoff. For new companies or ventures that have a limited operating history (under two years), venture capital funding is increasingly becoming a popular – even essential – source for raising capital, especially if they lack access to capital markets, bank loans or other debt instruments. The main downside is that the investors usually get equity in the company, and thus a say in company decisions.
In a venture capital deal, large ownership chunks of a company are created and sold to a few investors through independent limited partnerships that are established by venture capital firms. Sometimes these partnerships consist of a pool of several similar enterprises. One important difference between venture capital and other private equity deals, however, is that venture capital tends to focus on emerging companies seeking substantial funds for the first time , while private equity tends to fund larger, more established companies that are seeking an equity infusion or a chance for company founders to transfer some of their ownership stake.
Features of Venture Capital Investments
- High Risk
- Lack of Liquidity
- Long term horizon
- Equity participation and capital gains
- Venture capital investments are made in innovative projects
- Suppliers of venture capital participate in the management of the company
Methods of Venture Capital Financing
- Participating debentures
- Conditional loan
Advantages of Venture Capital
- They bring wealth and expertise to the company.
- Large sum of equity finance can be provided.
- The business does not stand the obligation to repay the money.
- In addition to capital, it provides valuable information, resources, technical assistance to make a business successful.
Disadvantages of Venture Capital
- As the investors become part owners, the autonomy and control of the founder is lost.
- It is a lengthy and complex process.
- It is an uncertain form of financing.
- Benefit from such financing can be realized in long run only.
For small businesses, or for up-and-coming businesses in emerging industries, venture capital is generally provided by high net worth individuals (HNWIs) – also often known as ‘angel investors’ – and venture capital firms. The National Venture Capital Association (NVCA) is an organization composed of hundreds of venture capital firms that offer funding to innovative enterprises.
Angel investors are typically a diverse group of individuals who have amassed their wealth through a variety of sources. However, they tend to be entrepreneurs themselves, or executives recently retired from the business empires they’ve built.
Self-made investors providing venture capital typically share several key characteristics. The majority look to invest in companies that are well-managed, have a fully-developed business plan and are poised for substantial growth. These investors are also likely to offer funding to ventures that are involved in the same or similar industries or business sectors with which they are familiar. If they haven’t actually worked in that field, they might have had academic training in it. Another common occurrence among angel investors is co-investing, where one angel investor funds a venture alongside a trusted friend or associate, often another angel investor.