An Introduction to Venture Capital

Most businesses start with a great idea. However, not even the best ideas can go far without adequate funds. Earlier, Anand Jayapalan had spoken about how ample financing is needed by a startup to get from vision to execution. Today many startup entrepreneurs, hence, seek venture capital funding to get the needed financial support in the initial stages of growth.

What is venture capital?

Venture capital (VC) is a form of private equity that funds startups, as well as early-stage businesses with little to no operating history but high potential for growth. Fledgling businesses typically sell ownership stakes to venture capital in return for not only financing, but also managerial expertise and technical support. VC investors ideally take part in the management of the startup, and help the executives of the young company to make smart decisions that help decisions to drive growth.

Founders of startups tend to have a high level of expertise in their chosen line of business, however, often lack the knowledge and skills needed to cultivate a growing company. VCs, on the other hand, have a good level of specialization in guiding new companies.

Venture Capital provides entrepreneurs with many other advantages. For instance, portfolio companies tend to get access to the VC’s network of experts and partners. They can additionally rely on the VC firm for assistance in case they need help in raising more money down the line.

Venture capital is a form of alternative investment that is generally available only to institutional and accredited investors. Wealth managers, high-net-worth investors (HNWIs), and major financial institutions are the ones to invest in VC funds.

What do venture capital firms do?

Startups typically approach VC firms in order to secure the funding they require to continue their operations or launch brand new operations. Subsequent to performing the required due diligence, venture capital firms would lend the funds to the chosen companies. In return for the funding, the VC firm would take an ownership stake that ideally is less than 50% in the startup company. A number of larger VC firms tend to take an active interest in making sure that the companies they have invested in succeed in the long run and become profitable. They try to achieve this objective in many ways, including taking an active interest in the sales, distribution and marketing of the startup.

Previously, Anand Jayapalan had pointed out that there are four major types of players in the venture capital industry:

  • Entrepreneurs who start companies and require funds to realize their vision
  • Investors willing to take on significant risk to pursue high returns
  • Investment bankers who need companies to sell or take public
  • Venture capitalists that profit by creating markets for bankers, investors and entrepreneurs

Startup founders and fledgling entrepreneurs looking for capital tend to submit their business plans to VC firms. If the VC considers a business plan to be promising enough, they would conduct due diligence to assess the quality of the business and idea. After a successful due diligence process, the VC firm would proceed to provide capital in exchange for an equity stake. Typically, the capital is provided in several rounds and the VC firm tends to take an active role in helping run the portfolio company.