Venture capital, a subset of private equity investing, usually represents money provided by investors to small or start-up companies with perceived long-term growth potential.
Venture capital can be injected into a company at any time the company wants to expand, sell-out, or merge with another company. Often VC money is invested after the start up (called the “Seed”) phase of a business and is usually a precursor to generating a return through an IPO or trade sale of the company.
The venture capital fund makes money by investing (owning equity) in companies with potential for enormous profitability and growth; when these companies increase in profitability, the investors earn profits. Fund managers often do not invest personal money in the fund, but share proportionately in returns on fund investments.
VC funding typically occurs at the beginning of the business, as previously mentioned, but can happen whenever the company needs additional funding.
VC investors carefully look for the following characteristics when considering investing in a company:
1. Experienced, proven management team
2. Dramatic growth potential
3. Capital-efficient/scalable business model
4. Significant barriers to entry
5. Highly differentiated products or services
6. Probable exit from the business from between three-and-seven years.
An experienced proven management team is often considered the most important characteristic of an investment.
Venture capitalists invest in all stages of the business, not just at the angel and seed stages, and the concept is appealing for new companies with very limited operating history, generally too small to obtain a bank loan or other debt financing. In reward for taking on the enormous risk associated with a new business, VC firms usually require significant equity in the company – often exceeding 50 percent. In addition to equity they usually require at least one board seat as well as a strong voice in day-to-day operations.
Since the explosive growth of high technology firms beginning in the 1970s, VC firms have been looking for the next high technology wave like Google. Nevertheless VC firms have continued to invest in all areas of business including:
Business Products & Consumer Products
Communications & Media Technology:
Consumer Products & Services:
Enterprise and Infrastructure Technologies
Food & Beverage
Health Care Products
Media & Entertainment
Oil, Gas, and Energy
Retailing & Distribution
Travel & Hospitality
Waste & Recycling
There are six stages of venture capital round funding that correspond to these stages of a companies development and capital needs:
1. Seed: Typically a small amount of money invested by either crowd funding or angel investors used to prove the idea (proof of concept).
2. Start-up: Early stage firms that have a proven concept that need funding for product development and marketing.
3. Growth: Funds used for initial sales and manufacturing (Series A Funding).
4. Second-Round: Operating funds for early stage companies that have started selling but have not yet shown a profit.
5. Expansion: Funding for expansion of a newly profitable business.
6. Exit: Funds used for the going public process (IPO) (called “4th round funding” or bridge financing).
Between the first round and the fourth round, venture-backed companies often seek (venture debt) specialized banks or non-bank lenders to fund working capital or capital expenses, such as purchasing equipment.