Everything You Need to Know about Venture Capital
The term “venture capital” is used a great deal in the context of entrepreneurship and the establishment of new startups today. We look at what venture capital actually is, the criteria venture capital firms use to seek out promising new startups, and the benefits of venture capitalism itself.
Venture Capital Basics
Venture capital is private financing to fund the startup of new businesses. Funds may be acquired from private individuals, or they may be obtained from investment banks and other financial institutions. Venture capital does not just have to mean financial backing or assistance, it is also sometimes provided in the form of managerial or technical expertise.
This form of private equity investment is used to finance small businesses that show exceptional growth potential. It is also used to boost funding for new startups that have expanded quickly and seem likely to continue to grow rapidly. Investing in a new, unproven business can be risky for investors. However, this form of investment can attract lucrative returns.
Venture capital funding is an increasingly popular way of financing new ventures, or growing businesses that have a limited history. It is an effective way for companies to raise capital if they lack access to corporate loans, capital markets, or other debt instruments.
The main downside to raising funds in this way is that investors often acquire a share in the company in return for their investment. This means they may acquire management rights and have a say in company decisions. Startup leaders should therefore make sure their vision is shared by any venture capital investors.
Venture Capital and the Startup Lifecycle
The first stage of a company’s lifecycle is known as the seed stage. At this point, the business represents a very risky investment. It may not even exist yet; it may simply be a concept. Few venture capitalists are interested in investing in any business at this stage, with companies receiving just 7% of all US venture capital funding at this point.
Next comes the early stage of the company. This stage also incurs a high degree of risk for potential investors. Will the company surmount the numerous obstacles and teething problems that come with starting a new business? Does it have strong leadership? Is the market healthy? Is there demand for the service or product?
The third round of investment is known as the expansion stage. The more mature a company is, the larger the sums it is likely to need in order to grow the business.
Finally, the late stage investment begins. This is when further, and probably much larger injections of capital are needed in order to continue to grow the business.
The Basics of a Venture Capital Deal
Venture capital deals create large ownership “chunks” in a company. Venture capital firms create independent limited partnerships to sell off these chunks of the company to a set number of investors. Sometimes independent limited partnerships consist of a group of several different enterprises.
What sets venture capital apart from other types of private equity is the fact that venture capital focuses on emerging companies seeking cash injections for the first time. Other forms of private equity are usually sought by bigger, more established businesses seeking a boost in equity — or an opportunity to transfer some of the company founders’ ownership stakes.
The History of Venture Capital
This type of investment is essentially a form of private equity. The roots of private equity can be traced back to the 1800s. However, this form of investment only really became popular following World War II.
Professor George Doriot of the Harvard Business School is considered the “Father of Venture Capital.” In 1946, he established the American Research and Development Corporation, raising a $3.5 investment fund to finance companies marketing pioneering technologies that were developed during the war.
The first company the American Research and Development Corporation invested in had ambitions of using x-ray technology to treat cancer. Professor Doriot’s $200,000 initial investment turned into $1.8 million when the company was floated in 1955.
Venture Capital Today
Today there are more than 1,000 active venture capital firms in the United States, with droves of wealthy individuals ready to fund promising new business ventures. Silicon Valley is largely regarded as North America’s venture capital mecca, with 70% of North American venture capital funding funneled through the region.
America’s West Coast accounts for more venture capital deals than any other area. The MidAtlantic region takes second place, accounting for around 20% of North American venture capital deals.
Software Attracts More Venture Capital Investment than Any Other Industry
Figures published by Statista suggest that the software industry attracted more venture capital investment than any other sector in the United States in 2018. Software accounted for more than 31% of total venture capital funding that year. Next comes biotech at just over 15%, with the industrial/energy sector at just over 10%.
Venture Capital Firms Help Private Individuals Identify Promising Startups
Venture capital firms primarily target new, smaller-sized businesses that may be high risk, but show potential for explosive scalability. Venture capitalism is not for the faint-hearted, however, this form of investment can attract colossal returns.
