Venture Capital: What It Means and How It Works
In the world of business and entrepreneurship, there are a few selected people called venture capitalists. For this set, their jobs typically hinge around supporting high-growth startups by financing them through the early stages of the business as they aim to attain greater heights. This financing or funding, which venture capitalists offer is, in business terms, referred to as venture capital, and has been one of the most profound reasons why most of your popular entrepreneurs – like Jeff Bezos and Elon Musk – succeeded in their businesses.
Venture capitalists (or VCs) are very fundamental to the life of business corporations because they can invest a large amount, offer advice thanks to their years of expertise, and partly shoulder the risks for the real owners. Also, VC’s presence in the business can serve as a major driving force for an enterprise to experience potentially rapid growth in as little time as possible. There are so many other interesting attributes which that venture capital has in the business and entrepreneurship world, this is why in this article, we will try to expertly define venture capital, its types and form, and why they are so important in the typical business industry.
Table of Contents
- 1 What Does Venture Capital Mean?
- 2 Who Are The Venture Capitalists?
- 3 Types of Venture Capital
- 4 How Does A Venture Capital Investment Work?
- 5 How Did Venture Capital Start?
- 6 What Are The Five Phases In Venture Capital?
- 7 Is Venture Capital That Important To The Entrepreneur and Business Owners?
- 8 Is Venture Capital Really Worth Risking For Small Business?
- 9 REFERENCES
What Does Venture Capital Mean?
Venture capitals are funds or monies invested in innovative enterprises, usually at their early stages, by venture capitalists to own a stake or share of the business. It is a type of private equity that typically involves an individual or a group of investors financing or providing finding resources for business startups with high potential for success in the long run. Venture capitals usually involve a lot of money, therefore, raising them means the source must be wealthy and have a lot of faith in the business project. Although venture capital comes mostly in the form of money and other instruments and securities, it can sometimes take the form of the experience and expertise of the venture capitalist – who is willing to offer his knowledge to guide such up-and-coming enterprise to the much-desired height.
Who Are The Venture Capitalists?
Venture capitalists are simply the fundraisers for bright and promising companies that are just getting into the business but have a high possibility of growing and expanding. These sets of people can come in a variety of ways, however, some of the most common ways include them coming as angel investors or HNWIs (High Networth Individuals), private investors, corporate organizations, investment banks among others. Angel investors or HNWIs and private investors can decide to invest in a certain enterprise with high growth even though they may know little or nothing about such an enterprise.
The important thing is that they have the money and have decided to support such a company because they have seen that it had a promising future, one which can rake in a lot of money for them. In these same manners, corporate organizations and investment banks can also spot promising startups, but unlike most wealthy individuals who may not know much about the business, investment banks and corporate organizations are experts and connoisseurs in their rights, and would only invest in what they are 90 to 95 percent sure of the outcome.
Types of Venture Capital
There are several types of venture capital and each is determined by their size, the type of risks they take, and the specific type of function they perform in the life of a business enterprise. Some of the more popular ones include – industrial venture capital, investment banks, and private venture capital partnership.
1. Industrial Venture Capital
This kind of venture capital involves industry-interest private investors and HNWIs who pool funds to support startups that have a high probability to excel in the nearest future. Firms with such promising likelihood might include fintech and other high-tech companies that are driven by cutting-edge innovations in technology.
2. Investment Banks
These are specialized business corporations prized with the responsibility of trading of company’s shares and other securities to well-off private and public venture capitalists. The activities of investment banks help bring about an expansion in companies’ capital assets, and this typically aims for the full maturity and establishment of any given startup firm. Investment banking organizations can sometimes create their venture capital department in other to take advantage and be the sole provider of high risks capital needed for the startup’s growth and expansion through the early phases to the bridge.
3. Private Venture Capital Partnerships (PVCP)
This is arguably the biggest venture capital pool that can be mustered and managed by venture capitalists. The major aim for the investors here is to fund-sponsor firms and businesses that are profit-trustworthy and are, in a worst-case scenario, able to guarantee an ROI of up to 30 percent per annum. This group of venture capitalists is mostly very active in the business, starting from early on till the maturity phase, and able to infuse massive numbers of financing to the tune of more than 500 million dollars at every phase they oversee.
How Does A Venture Capital Investment Work?
A venture capital investment takes place when a company with high growth potential puts for sale a good portion of its shares out to the public prompting a few private investors to purchase them, usually through a private partnership program set up by organized venture capital firms.
At one time, a venture capital input can seldom come from one single individual, but at other times it usually involves corporate partnerships in which several related enterprises come together early on in the business for pooling of resources. This is, in fact, the major difference between venture capital and other forms of private equity arrangements – considering that these are more interested in funding an already large and successful company whose founders seek to relinquish a portion of their ownership.
How Did Venture Capital Start?
Real development in venture capitals can be traced as far back as world war II in the United States, before which only very few HNWIs and their families, such as the Warbucks and Rockefellers, were in the business of raising venture capital for high potential startups and companies. Consequently, thanks to George Dariot, the emergence of the ARDC (American Research and Development Corporation) in the mid-1940s marked the beginning of the first-ever publicly owned venture capital firm. With ARDC coming into the picture, venture capital and other types of funding programs became more accessible to more promising startups, as it was not only the HNWIs who could raise venture capitals for emergent businesses.
From the late 1950s, the practice of venture capital entered a new and improved phase, more so with the promulgation of the SBI (Small Business Investment) Act, which afforded SBA (Small Business Association) with the right to license small scale startup investment firms in the US. This Act was very important for the development of venture capital because it made available to up-and-coming businesses a form of low-cost funding which had government backing to help scale such establishments.
From the 1980s, the venture capital industry hit a snag thanks to factors such as the proliferation of inexperienced fund managers, and highly competitive clime – especially coming from the Asian markets. The industry, however, resumes normal activities from the early 1990s before hitting a stumbling block with the dot-com era of the early 2000s after which it manager a consistent upsurge to date, recording a massive growth of more than 45 billion dollars as of 2014.
What Are The Five Phases In Venture Capital?
Infusing venture capital into a business with good prospects typically always starts from the early stages of such business, but in general, venture capital is very important for the entire lifespan of the business and can work at various advanced stages beyond the beginning phases. There are five standard phases to which an entrepreneur can strive to convince the venture capitalist to secure venture capital financing for his business projects. They are; the seed, startup, first, expansion, and bridge stages.
1. The Seed Phase
This is the very first stage that presents a good opportunity for the entrepreneur to draw in the fundings from venture capitalists in the form of venture capital. Here, the entrepreneur or business owner merely just has a product concept or idea that has not fully developed into something substantial or tangible. So, the goal here for such an entrepreneur is to try and gain the trust and conviction of the venture capitalist by proffering these business ideas and concepts in a way that looks very promising and unsusceptible to future failures or breakdowns. If this is done well, coveted venture capitalists who have genuine interest might see growth potential in such business idea thereby making arrangements for the provision of funding for its product development, business plan and strategy, research, and of course its management.
2. The Startup Phase
This is the phase that precedes the seed phase and generally involves the venture capitalist marshaling a huge investment into the entrepreneur’s promising business concept and ideas to get it set up and running. Major aspects that the entrepreneur or business owner must have touched and achieved here include a completed; market research, business plan, and strategy. Also, continued marketing and advertising of products and services are very likely incorporated at this phase. With this to show, the entrepreneur can now pitch his product prototype to potential angel investors and venture capitalists to support higher-up corporate financing that is beyond what the real owners can afford.
3. The First Phase
This phase is typically more financially demanding than all the other previous phases because the company now decides to begin production, sales, and distribution. The entrepreneur needs the input of venture capitalists at this point in other to be able to acquire land and other assets to be used to set up physical manufacturing locations. Also, the raw materials for production, or services software, are capital intensive and can be better handled with the venture capitalist in the picture. Businesses that fall within this first phase category are majorly up-and-coming and their products are known to usually have a high commercial viability ratio.
4. The Expansion Phase
From this phase, the business should already be trading its product and services, but with customer demands tripling products supply, there is an imminent need to expand to meet demands. This is the part where the venture capitalist can come in to serve as a major funding source for the business as it seems to match customers’ requests for products and services. Some of the notable improvements the company may oversee here include; buying more product raw materials or services software, branching the business, expanding production grounds, franchising, and building a conglomeration et cetera.
5. The Bridge Phase
This phase heralds a fully matured business worthy of transitioning into a PLC (Public Limited Company). The company, at this stage, needs bigger financing support from HNWIs or other venture capitalists and investors to complete a merger, IPOs, and acquisitions. Also, at this stage, investors may decide to withdraw their support and decide to sell off their share for a huge ROI (Return On Investment). But this withdraw does not hamper the business but instead allows for a space for other keen venture capitalists to acquire shares and Target a massive gain from the business’ IPOs (Initial Public Offerings).
Is Venture Capital That Important To The Entrepreneur and Business Owners?
Venture capital is considered very important and basic to the entire success of business owners and entrepreneurs and has been touted by experts as the nucleus of the capitalist economy. This is because most businesses with growth potential often come as high-risk, capital-intensive firms. For the entrepreneur or business owner, the load becomes too heavy and expensive to carry alone, and they would certainly need to outsource some challenges to HNWIs and other investors who have the capacity and willpower to carry such hassle. For this purpose, the company then creates shares and puts them out for sale and to bring by interested investors – who through acquisition obtain equity and certain corporate rights to the business.
Is Venture Capital Really Worth Risking For Small Business?
There is always going to be a high risk for the up-and-coming enterprises, so the venture capitalists must always have an open mind, staying awake to the possibility of failing and losing money and other investments if they choose to invest. As matter of fact, it is common to believe that three to four in every ten high-growth startups fail in the long run. But never the less, venture capitalists know that risks of failure are part of the business so they are always ready to invest in start-ups – provided they are convinced and given enough reasons as to why their risk will be rewarded.
Entrepreneur. “Venture Capital.” https://www.entrepreneur.com/encyclopedia/venture-capital
CFI. “Venture Capital Funding For Early Stage, Emerging Companies.”https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-venture-capital/