In short, venture capital is money designed for high-risk investment in startup enterprises. It involves high risk for the investor in beginning ventures or later stages to continue expected progress and growth. It also holds out the possibility of large profits in exchange for the risk of investing.
Venture capital differs from standard bank financing. Instead of paying back a conventional loan within a designated time period at a predetermined rate of interest, venture capital fund investments are repaid through a negotiable percentage of the entrepreneur’s stock in the business over three to seven or eight years as the company succeeds and grows. In most cases, a successful initial public offering (IPO) will allow both investor and entrepreneur to prosper by bringing the company’s stock to the public market.
Usually, the terms of ownership are negotiated and predetermined before a venture investor will conclude the financing.
How a venture capitalist chooses to structure his investment depends on the style and track record of the venture fund. It can be straight equity, a combination of equity and loans, or a sliding scale of reversion from majority control of the entrepreneur’s stock to minority ownership upon achievement of certain milestones. Sales and revenues or an anticipated (IPO) are perennial favorites.
The advantages of venture capital for an entrepreneur are quickly apparent. There is usually no requirement to repay a bank loan. The venture capitalist and the entrepreneur assume some of the risk of the new business together. Better, there is usually no requirement to tie up funds dedicated to interest. That factor alone can be used to propel the business forward.
Further, the venture capital firm can often bring much needed expertise to a new entrepreneur’s business. Beyond capital, knowledgeable and well-connected investors can further lend invaluable knowledge to the startup firm.
Sharing ownership and control of the entrepreneur’s business is often considered the chief disadvantage of the involvement of venture capitalists. This is often the main reason for lack of success for small, inexperienced entrepreneurs, resulting in a failed deal.
Before even considering the small, but powerful area of venture capital, the entrepreneur must know and understand two chief areas of concern
- First, the entrepreneur’s industry expertise and background should be flawless. It should be on the cutting edge of industry development.
- The startup company must understand the rigors of successfully running a business, as well as marketing, no matter its industry.
- It should show a third-party perspective to prove the need for its product by the industry or retail consumer.
- Finally, it should clearly demonstrate the fact that the proposed business can grow and achieve profitability in record time.
Secondly, the entrepreneur should consider the most appropriate “fit” with the chosen venture firm. That requires an understanding of the venture firm’s preferred emphasis on investment, the expected time frame for funding, its venture partners, successful previous funding and desired geographic locale.
The job of choosing a venture capital source is far from simple.
It runs the gamut from your wealthy cousin who has always liked you and has just inherited a few hundred thousand or millions of dollars. He might be one of a handful of people who know you directly and can serve as “seed capital” funders for you and your enterprise.