Venture capital is a type of funding for new/ startup/ growing business. The capital usually comes wealthy investors (also known as venture capitalist), who gives funding to new company in exchange for equity in the startup with a long-term growth perspective. Venture capitalists have the power to influence major decision of the companies they are investing in as it their money at stake.
This practice is very common nowadays, especially when technology and money are moving ahead of life in the business world. Many of the big gun companies such as Apple, Microsoft, or even Google started out with venture capital funding.
While banks typically will not take the risk to give huge amount of loans to startups because the lack of solid financial foundation, venture capitalists look to the future.
Although loans and venture capital are both common methods for funding business, venture capital is very different from a loan. With a loan, a lender/ financial institutes (most commonly are banks) gives a company money, and the company has a contractual obligation to pay back the amount with interest on top over a certain period. In the case of many small businesses, the loan is backed by a personal guarantee from the business owner. The backing allows the lender to recoup some of its investment in case the loan is defaulted. With venture capital, the startup company issues private shares in exchange for money.
In a venture capital deal, large ownership of a company is created and sold to several investors through independent limited partnership established by venture capital firm. These partnerships sometimes consist of a pool of few other similar enterprises. One important difference between venture capital and other private equity deals, however, is that venture capital tends to focus on emerging companies seeking substantial funds for the first time, while private equity tends to fund larger companies that are seeking an equity infusion or a chance for company founders to transfer some of their ownership stake.
For small businesses, venture capital is generally provided by high-net worth individuals, also known as angel investors. They are typically a diverse group people who has amased their wealth through a variety of sources.
So how the venture capital process works? The first step for any business looking for venture capital is to submit a business plan, either to a venture capital firm or to an angel investor. If interested in the proposal, the firm or the investor must then perform a thorough investigation of the company’s business model, products, management and operating history, among other relevant criteria’s. Since venture capital tends to invest larger amounts in fewer companies, this background research is very important
Once due diligence or investigation has been completed, the firm or the investor will pledge an investment of capital in exchange for equity in the company. These funds may be provided all at once, but more typically the capital is provided in rounds. The firm or investor then takes an active role in the funded company, advising and monitoring its progress before releasing additional funds.
The investor exits the company after a period of time, typically four to six years after the initial investment, by initiating a merger, acquisition or Initial Public Offering (IPO).