Business Dictionary

Venture Capital

What is Venture Capital?

Venture capital is a type of financing given to small businesses or startups with high growth potential, often in exchange for a percentage of equity in the business.

Companies that are on a high growth trajectory will typically need multiple stages of financing as the demand for their product exceeds their ability to service that demand with organic revenues until they grow to a certain size where economies of scale form and they can sustain growth profitably on their own. As such, venture capital covers a continuum of growth beyond the startup phase.

Depending on the stage of growth the company is at, the funding comes from one or more sources such as high-net-worth individuals (angel investors), venture capital firms, or corporations with strategic investment arms.

Venture capital investors make money from capital gains. That is, when they can exit the business through the sale of their shares after the shares have increased significantly in value. Exits often occur after a merger, acquisition, or an Initial Public Offering.

Another opportunity for exits comes in the form of secondary share sales where in a late-stage financing, new investors purchase the shares of earlier stage investors at an agreed upon valuation.

Many high growth technology start-ups lack the track record and revenue that would give them access to other forms of funding like bank loans, debt instruments, and Initial Public Offerings because of a lack of assets and significant revenue. In this case, venture capital can be the answer if the company fits the growth profile of a venture backable company.

It is a highly risky investment so investors need to see the potential for higher returns than would be found in other investment opportunities like real estate or stocks and bonds.

Beyond cash, venture capital investors can help entrepreneurs with technical expertise, networks, mentorship, managerial assistance, or access to the right talent pool. 

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Venture Capital – Example

Let’s say you have a business idea you strongly believe will take off, but you don’t have the funds to bring the idea to reality. In this case you could pitch your idea to an angel investor or a venture capital firm.

In exchange for investing money and expertise into your business, they will ask to control a percentage of your company. For early-stage startups, that usually amounts to anywhere from 10% – 20% as they will need to retain enough equity to conduct further rounds of investment without giving up too much of their company at the beginning of their venture life cycle.

You can source funding for your business from a wealthy individual, your friends, relatives, business partners or established venture capital firms.

Different investors have different requirements for what they will invest in (e.g. industry, technology, stage) and not every venture capital firm invests in early-stage companies that don’t have proven revenues yet, so it’s important for you to do your research before determining who to approach.

Your business is going to have to fit with what the investor is looking for if they’re going to invest in your company.

Here are a few examples of venture capital firms, and the types of businesses they are looking to invest in:

Sequoia Capital: Usually invests in healthcare, mobile, financial, and energy businesses.

New Enterprise Associates (NEA): This firm focuses on technology and healthcare.

Intel Capital: Usually invests in technology businesses.

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Arden Tse - Business Expert - Ask A Business Expert

This business definition was written by Business Expert Arden Tse. Click here to learn more about his work.

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