What Is Venture Capital?

FT Contributor
An investor stands behind the words "venture capital."

Small businesses and startup companies might easily find themselves treading water if they don’t acquire financial help from investors. Venture capital and venture capitalists can help these companies and entrepreneurs overcome stunts in growth by providing money and assistance. According to Harvard Business Review, more than 80% of the money invested in businesses by venture capitalists goes to building a foundation that’s crucial for growth.

Table of Contents

Venture Capital Definition

Venture capital is funding that an investor gives to a company in exchange for a stake in the company. Also referred to as risk capital, venture capital is considered a high-risk investment.

A startup company can use an investor’s venture capital to grow their business. In return, the venture capitalist gets equity in the company, and therefore, some control over how the business is run. Venture capital firms provide the majority of venture capital to businesses today. These firms specialize in developing investment portfolios for clients who include high-risk investments, such as new business ventures, in their portfolios.

Venture capitalists hope that the money they invest in a business will grow as the business grows, since that’s how they make money from the equity they own. Venture capitalists want to see high and fast returns on their investments, so they usually invest their capital into promising new businesses or startups that are already established. They also look for industries that are proven to cater to fresh business ideas and startups, such as technology or healthcare.

Business owners may enlist the help of venture capitalists if they want to expand their current business, launch a new product or service, or need financial help to continue operating. In some cases, entrepreneurs starting businesses on the side may ask for assistance from venture capitalists simply because they need expert advice on reaching the next phase in their business’ growth.

Venture Capital Examples

There are many well-known and successful companies that grew their businesses with the assistance of venture capitalists. If it weren’t for their capital and leadership, these companies may not have been able to grow to become as successful as they are today.

Some of the most recognizable companies that used venture capital include the following:

  • Apple.
  • eBay.
  • Snapchat.
  • Groupon.
  • Facebook.
  • Spotify.
  • Google.
  • Twitter.

The venture capitalists who took chances on these companies in their beginning stages experienced big payouts for what may have seemed like risky investments at the time.

Forms of Venture Capital

There are two different venture capital vehicles: equity and convertible debt. Before you agree to do business with a venture capital firm, it’s important to understand the type of capital you’re committing to and how the deal is structured. With equity financing, you agree to give the venture capitalist a portion of your company’s equity in return for the investment.

This gives the investor a say in how your company is run and allows them to make money when you go public or liquidate your business. If the firm is experienced in your industry and your type of business, it can be helpful to receive guidance from them on how to grow your company. However, keep in mind you’re giving up control and equity of your growing business.

If you agree to convertible debt, the venture capitalist will provide you with funding but you’re required to pay it back with interest at a certain date. When your company begins to grow and you go through another round of fundraising, you agree to allow these investors to invest in your business and receive equity in return at a discounted price. It can be several years before a conversion occurs, so more risk is placed on the venture capitalist in a convertible debt agreement.

Venture Capital vs. Loans

While they’re commonly compared to one another, it’s important to note the differences between a loan and venture capital. If you recently graduated and you’re looking to start a business, you may have trouble obtaining a loan. Lenders usually require credit history and collateral, as well as proof that your business is successful before agreeing to give you a loan.

If your business does qualify for a loan, you’re provided with funding that you must pay back along with interest. Your collateral can be taken by the lender if you don’t pay the loan back.

When you raise venture capital funding, money is provided to you that you can use to grow your business. However, you’re required to exchange your company equity for this funding. While you aren’t required to pay the loan back, a portion of your business is now owned by the venture capital firm.

Venture Capital Stages

To identify where your business is and where it’s headed, venture capitalists break down your business cycle into stages, which include the:

  • Seed stage: This is the very first stage of your business, when you’re still developing it by yourself and the venture doesn’t hold much value.
  • Early stage: You’ve entered this stage if you’ve already proven your business’s profitability and you may have hired some staff.
  • Growth stage: If you’re in the growth stage, your business has already proven its success, you have a full staff, and revenue is growing consistently.

Venture capitalists contribute fewer funds to businesses in the seed and early stages since they haven’t proven their success. Investors offer more funding to those in the growth stage since they’re making more profit and have a clear path to continued success.

What Do Venture Investors Look For?

Venture capitalism is risky and investors are cautious about where they distribute their investments. To attract the attention of venture capital firms, you’ll need to prove the following:

  • You’re a large company and gaining success.
  • You can offer a stable return on investment.
  • There are success stories surrounding your business.
  • Your product or idea is innovative and has staying power.
  • You’re already public or plan to go public.

Don’t approach a venture capitalist for funding if your business hasn’t already proven its worth and validity in the market. Be ready to present your business’s current financials and future predictions, including your vision for growth.

How to Find a Venture Capitalist

It can be difficult to raise seed capital, especially if you’re looking for a venture capitalist. These high-risk investors are very particular about the businesses they invest in. You can try to connect with venture capitalists through:

  • Financial advisors.
  • Angel investors.
  • Crowdfunding sites.
  • Accountants.

When you identify venture capitalist firms you’re interested in working with, it’s important not to send the same pitch in bulk to multiple potential investors. Take the time to present your business in a unique way and prove you’re already successful and looking forward to more growth.

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