Investors that bet on a company’s long-term growth potential supply it with a special type of financing known as venture capital (VC). Venture money is typically provided by wealthy individuals, investment banks, or other financial institutions.
Value is not only monetary but can come in the form of technical or management expertise as well. Small businesses that have shown rapid development and are set for further expansion are the traditional recipients of venture capital.
Funding might be hazardous, but the prospect of above-average returns is enticing. In the absence of access to capital markets, bank loans, or other debt instruments, venture capital is becoming an increasingly popular—and essential—the source of acquiring money for new enterprises and initiatives with a limited working experience (under two years). The primary drawback is that investors will have a voice in corporate affairs because they will have ownership stakes in the business.
Venture Capital History
Private equity includes venture capital as one of its subsets (PE). Although private equity (PE) has been around since the 19th century, the venture capital business didn’t take off until after WWII.
Georges Doriot, a professor at the Harvard Business School, is often called the “Father of Venture Capital.” In 1946, he established the American Research and Development Corporation (ARD) and successfully secured $3.5 million to invest in businesses that were commercializing technologies created during World War II.
The initial business in which ARDC invested planned to employ x-ray technology in cancer therapy. When the company went public in 1955, Doriot’s initial $200,000 investment was worth $1.8 million.
Affected by the Great Recession of 2008
The venture capital business took a hit when institutional investors, who had just emerged as a significant source of money, pulled back after the financial crisis of 2008. Unicorns, or firms valued at over a billion dollars, have drawn a wide range of participants to the IT sector since their inception.
The hordes of investors seeking return multiples in a low-interest-rate environment have been joined by the likes of sovereign funds and famous private equity companies, all of whom have participated in high-value deals. The venture capital ecosystem has shifted as a result of their arrival.
The Pros and Cons of Using Venture Capital
Capital from venture capital firms is available to startups who do not have the resources to take on debt or access stock markets. Companies can get the money they need to get started, and investors can acquire a piece of potentially successful businesses, all thanks to this arrangement.
An investment from a venture capital firm also has a number of other upsides. In addition to providing financial backing, VCs also offer mentorship and networking services to help startups identify key personnel and industry experts. The support of venture capitalists can be used to attract additional funding.
In contrast, when a company takes on venture capital funding, it may give up some of the autonomy over the company’s future that had previously been exercised by the founders. Venture capitalists will undoubtedly want a sizable stake in the business, and they may start exerting pressure on the management team. Many venture capitalists (VCs) are simply interested in a quick, high-return payback and may put pressure on the company to sell.
Pros
- In contrast to traditional bank loans, venture capital funding does not necessitate a stable cash flow or substantial assets from the company seeking the money.
- Venture capitalists (VCs) can help a startup obtain talent and thrive by providing mentoring and access to its extensive network.
Cons
- Venture capitalists typically want a sizable stake in the company as compensation.
- Companies that take venture capital funding risk having their creative freedom stifled by the demands of their backers.
- Venture capitalists (VCs) may also put pressure on a company to maximize the return on their investment rather than focus on long-term expansion.
Venture Capital Vs Angel Investors
Venture money is typically supplied by high net worth individuals (HNWIs), commonly known as “angel investors,” and specialized investment organizations to small and growing enterprises in developing industries. Hundreds of businesses that provide funding for new and exciting ventures are members of the National Venture Capital Association (NVCA).
Typically, angel investors are a heterogeneous set of individuals who have obtained their riches in unconventional ways. However, these people are typically other business owners or former corporate leaders.
There are commonalities among self-made millionaires who invest in startups. The vast majority of investors seek out organizations that are professionally run, have a solid foundation upon which to build, and show promise for rapid expansion. In addition, these backers are more likely to provide capital to businesses operating in the same or a closely related industry or market segment. They may have academic training in the field if they haven’t worked there before. Angel investors frequently work together with other angel investors to fund new businesses.
Capital-Investment Tendencies
The original purpose of the funding was to get a new business sector off the ground. For that purpose, Georges Doriot maintained a mindset of hands-on involvement in the development of the new venture. He helped business owners by giving them money, advice, and contacts.
More inexperienced investors have been able to enter the market for small firms and startups since the SBIC Act was amended in 1958. The industry’s increased access to capital coincided with a rise in the number of unsuccessful start-ups.
The venture capital industry as a whole has come around to Doriot’s original notion of serving as a sounding board for business owners.
Is Venture Capital Long Or Short Term?
Expense investments (production, marketing, and sales) and the balance sheet account for what we estimate to be greater than 80% of venture investors’ money (providing fixed assets and working capital). Capital allocated for venture capital investments is not intended for long-term use.
The Development of Silicon Valley
Due to its proximity to Silicon Valley, the venture capital industry focuses almost exclusively on the internet, healthcare, computer hardware/services, and mobile/telecom deals. However, VC finance has also aided a variety of other sectors. Staples and Starbucks, for instance, are two well-known companies that have received venture capital.
The most successful companies are no longer the only ones able to get venture funding. In addition to individual investors, the competition also includes institutional investors and well-established businesses. Technological behemoths like Google and Intel each maintain their own venture funds to invest in cutting-edge startups.
Additionally, Starbucks announced 2019 a $100 million venture fund to finance food technology companies.
The venture capital industry has evolved over time, with larger average deal sizes and the inclusion of more institutional investors. There is currently a wide variety of companies and investors operating in this space, each with its own investment style and comfort level relative to risk.
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