An Introduction to Venture Capital
Venture capital is a type of private equity investment that finances startup companies estimated to have the potential for long-term growth. Venture capital comes from a variety of sources, including investment banks, high-net-worth individuals, and angel investors. Although it is mostly provided via funding, venture capital could also be expertise in a particular industry provided by a more experienced party.
A venture capital deal happens when a substantial ownership percentage of a business is sold to investors using independent limited partnerships created by venture capital firms. Using venture capital as a source of finance is becoming more rampant among companies operating for less than two years. Because the companies invested in are usually startups, investing in them can be quite risky. However, the returns are quite attractive, and investors have a say in company issues because they have equity.
Venture capital originates from private equity, but there is a fundamental difference between the two concepts. Venture capital focuses on startups that need initial substantial financing, while private equity investors and firms fund already established companies that need a cash influx.
When startups seek venture capital, they send a business plan to a venture capital firm or angel investor. Afterward, the venture capital firm performs due diligence, comprehensively examining the startup’s management, products, and business model, among other important factors. Venture capitalists are usually very careful with their investments because they provide large amounts of money to few companies.
After performing due diligence, a venture capitalist firm or angel investor promises to provide capital for a stake in the company. In most cases, the investor or firm provides the funds in batches. Prior to investing the whole sum agreed upon, the investor begins to play a role in the company as an advisor and leader.
Typically, venture capitalists specialize in a particular industry. For instance, a venture capitalist who invests in tech may have worked as a tech industry analyst. Venture capitalists also generally have investment experience. Some have an MBA, while others have worked as equity research analysts.
Apart from venture capitalist firms, examples of institutions that invest in venture capital include pension funds, insurance companies, and financial firms. These firms push a small part of their funds into high-risk investments, such as new companies, and anticipate a 25 to 35 percent annual return. Various factors determine how much ROI they will get and the stability of their investment. One such factor is the timing of the investment.
Venture capitalists invest in industries that are likely to be sought after later. For instance, in the 1990s, about 25 percent of venture capital funds went to internet companies.
Generally, venture capital firms do not invest in companies that pioneer an industry because success is hardly predictable at that point in the industry’s growth. They also avoid the already established industries with a lot of competition and consolidation that can result in a slow growth rate. Venture capitalists aim to invest in the adolescent phase of an industry or company’s life cycle, when the growth rate is high, enabling them to make higher profits at lower risk.
Originally published at http://markbelinsky.wordpress.com on November 16, 2021.