What does VC mean? Venture capital, or VC, is an institutional or private equity financing that investors provide to early-stage startups and emerging companies. To better understand venture capital, it’s essential to define venture. To venture is to undertake a journey with risks involved, such as uncertain outcomes. Venture capital is risky, but it can lead to impressive returns if invested in the right venture.
What Is Venture Capital?
You may be wondering, “What is VC all about?” and “Why would investors be putting too much risk for a business venture that is risky?” Venture capital is the money invested in small businesses that has a great potential to develop and grow. It can be dangerous for investors to fund a startup venture, but still, these people are in the industry to look for feasibly high returns and attractive payoff. A startup venture capital is invested in exchange for equity and is not given as a loan.
The father of venture capital is Georges Doriot, a Harvard Business School professor. He initiated the American Research and Development Corporation (ARDC) in 1946. He raised a $3.5 million fund to invest in companies related to technologies during World War II. The first investment of ARDC was in a company that envisions using X-rays for the treatment of cancer. The $200,000 that he invested became $1.8 million in 1955 when the company went public.
This is how startup or emerging companies grow, and the investors either lose or win big. Many investors try their luck in investing their capital in businesses with exceptional long-term growth prospects or potential. The capital is known as venture capital, and the investors are called venture capitalists.
There are four leading players in the venture capital industry, these are:
- Business people who need funds
- Investors looking for high returns
- Investment bankers looking for companies to sell
- Investors who can make money for themselves by providing a market for the other three players
If you are looking for venture capital, you’ll be asked to submit a business plan to a venture capital firm or other investors. If you successfully made the venture capitalist interested, they will conduct a thorough investigation of your company’s products, business model, operating history, and management. This background research is necessary for investors so they’ll have an informed decision whether they’ll invest a small or more considerable amount of money.
About Venture Funding
Venture funding can be provided at once, but the fund is usually provided in rounds. The investor or firm will then take an active role in the funded company. They can advise and monitor the progress of the company before they release additional funds.
There is a common belief that venture capitalists invest in great ideas and good people. The reality is, they invest in promising industries — more competitive industries. This means that regardless of how charismatic and talented entrepreneurs are, they will hardly receive venture capital if their businesses are in a low-growth market.
Picking the wrong industry to fund or betting on a technology with unproven market growth is often avoided by venture capitalists. If they invest in a business with a high growth rate, they will have better opportunities for high returns. In any industry, the “high risk, high return” mantra is still true.
Who Are the Venture Capital Investors?
The funding for venture capitalist businesses usually comes from wealthy venture capital investors, banks, and other financial institutions. The investments are not just financial; they can be technical or managerial expertise as well. The investors who are providing funds are gambling that the startup venture will be successful and will not deteriorate.
Venture capitalists are established as limited partnerships (LP). A limited partnership is composed of two or more partners. The general partner handles and oversees the business, while the limited partner doesn’t contribute to managing the business. The general partner of LP has unlimited liability for debts. In contrast, the limited partner has limited liability on the amount of their investment.
High Networth Individuals
For a startup or small businesses, venture capital is usually provided by High Networth Individuals (HNWIs). They are also known as angel investors. The National Venture Association (NVCA) comprises a large number of venture capital firms that offer to fund or invest in innovative enterprises.
They are likely to offer funds to companies with a concrete business plan, well-managed, and assured of substantial growth. They look to invest in business ventures with which they are familiar, so they have a complete understanding of the venture’s potential.
Many venture capital investors already have prior investment experience, such as equity research analysts. Other investors have an MBA or Master in Business Administration degrees. They also tend to invest in a particular industry such as health care if they have experience in the field, like being a healthcare industry analyst. When these investors finally decide, they will pledge capital in exchange for equity from the company.
Why Businesses Need Venture Capital Financing
Below are some reasons why most business people or entrepreneurs need funding during the early life of businesses:
- Capital investments. New companies need funds for buying real estate, purchasing equipment, and building facilities that typically exceed the ability of the company to fund its own.
- Cash flow challenges. Before generating cash from sales or profit, materials and inventory must be purchased, advertising should be paid, and employees need to be trained. The new company or startup business will need funding from investors to answer these early expenses.
- Product development cycle. Before a company generates earnings, some products undergo research and development for years. The costs usually exceed the ability of the company to fund these activities.
- Fees, licenses, and permits. When entrepreneurs start a business, it needs to be registered, applied for a business license, permit, etc. Fees and permits depend on the type of business as well.
- Unanticipated expenses. Startup businesses need to have a cash reserve for unexpected expenses that might arise. Some of these expenses might be insignificant, but some may also affect the business significantly.
To generate more funds, entrepreneurs can also get equity fundings. The only problem with this type of funding is that the entrepreneur may lose control of some aspects of his business. The investor will also receive a return of investment in the form of dividends. Below are some forms of equity funding:
- Venture capital (VC) firms. Venture capital is the money invested by venture capital firms to small businesses and startups with growth potential—the majority of the venture capital follow-on funding for businesses that angel investors initially funded.
- Business angels. These are wealthy private investors or individuals who invest their capital directly in startup businesses. They fund emerging businesses with their own money with the hope of earning a high profit if the business becomes a success.
- Initial public offering (IPO). This is the first sale of stock by a company to the public. This is an important milestone for a company because, typically, a company will not go public unless it has demonstrated a bright future.
- Private investors. These investors can either be friends or family members of the entrepreneur. They are often willing to give a hand in providing financial assistance. When friends and family invest, it’s better to have a written contract and a payment schedule agreed upon by both parties. This is necessary to keep an amicable relationship with your family and friends whether the business takes off or not.
- Public stock sales. To raise capital, a company can sell shares of its stock to the public.
Aside from equity fundings, debt financing can be a source of funds for businesses as well. It involves selling corporate bonds or getting a loan.
Below are some sources of debt financing:
- Bank loans. When giving credits, banks often rely upon provisions such as: if there is a market for the business, the value of collateral, credit record of the applicant, ability of the business to repay the loan, etc.
- Government financing programs. The government offers financial assistance programs for small businesses. Some financial assistance provided includes improving the workplace, developing products or technology, promoting products or services, and restructuring debts.
- Finance companies. These companies are an alternative source of financing when commercial banks reject loans for new ventures. These companies are more interested in funding high-risk business ventures. They also tend to charge higher interests compared to commercial banks.
- Asset-based lenders. These lenders are willing to give loans, but with the condition that idle assets like accounts receivables will be committed as collateral.
- Trade credit. This is another option for business people to extend their credit in the form of delayed payment.
Below are the two common types of loans:
- Line of credit. Borrowers may use credits at their discretion. Borrowing capacity is established first.
- Single-purpose loan. A specific amount of money can be borrowed, but it must be repaid in a fixed amount with interest.
- Bank loans.
The advantage of debt financing is that no part of the ownership of the entrepreneur is surrendered. The interest on a loan is also tax-deductible in contrast to dividends for equity funding. PIRScapital offers funding for small businesses to drive more sales and even increase profitability
Advantages and Disadvantages of Venture Capital Financing
Since we already know that venture capital is a mechanism wherein venture capital investors support entrepreneurs by providing funds and business skills, here are its various advantages and disadvantages:
- Help entrepreneurs to gain business expertise. Supplying venture capital funds will help the owners in their decision making especially financial management and human resources.
- Owners will not need to repay. Business owners or entrepreneurs are not required to pay the money invested. Even if the company fails, they are not liable for repayment.
- Help raise additional funds. VC investors fund more capital if the business increases its value by bringing in other investors.
- Personal assets are not pledged. Most venture capitalists’ agreements don’t include business owners’ assets.
- Helps in networking or valuable connections. Partners of venture capital companies spend as much as 50% of their time building connections to assist the companies they invest in. Having access to networks can help entrepreneurs find new partners, build a client base, and raise future funding rounds.
- Increased exposure and publicity. The majority of venture capital firms have a public relations (PR) group and media contacts — it’s in their best interest to expose your startup business. The increased publicity will lead to being noticed by potential customers, employees, and other venture capital firms interested in investing.
- Reduction of ownership. This is the primary disadvantage of VC. Entrepreneurs will give up a part of their ownership in the business. Many companies will need more funding aside from the initial fund. They will need to raise additional funds from venture capital firms. This will result in losing their stake in the company, such as the power to make decisions.
- Finding investors can be time challenging. New businesses need fundraising when other sources of funds have been exhausted. The problem is, fundraising can take several months and even years to raise enough money for their business.
- Extensive due diligence is necessary. It’s vital for venture capital partners to screen startup businesses thoroughly because the money they invest belongs to outside contributors. The two stages of due diligence include:
- Your business’s business fundamentals and technology will be evaluated to determine if the business can be scaled or the market exists.
- They will conduct a more in-depth review of your business background and its financial and legal position.
- Funds are released depending on business performance. Funds from business capital companies are released gradually depending on business milestones.
Silicon Valley Venture Capitalist: The Center for VC Markets
For the last five decades, Silicon Valley has been the world center for venture capital markets, innovation, and technology investments. The Silicon Valley venture capitalist model of doing deals is widely used around the world. Silicon Valley is the largest concentration of technology worldwide, supporting more than 6,600 technology companies worldwide.
Below is a list of Silicon Valley venture capital companies and firms:
- Accel Partners. Accel invests in networking and communication, media, software, consumer durables, and healthcare technology systems. Its vision is to identify and invest in companies responsible for the growth of next-generation industries.
- Andreessen Horowitz. This firm helps entrepreneurs who think big, move fast, and are committed to building major technology franchises.
- Venrock. Venrock backs entrepreneurs to build some of the world’s most successful companies. It invests in pharmaceuticals, biotechnology software, and communications and networking.
- New Enterprise Associates (NEA). This is one of the world’s most active and most prominent venture capital firms. It invests in healthcare and technology worldwide.
- Khosla Ventures. This firm that was founded in 2004 provides strategic advice and venture assistance to entrepreneurs who are working on breakthrough technologies.
- Sequoia Capital. Sequoia firm helps daring entrepreneurs to build legendary companies. It invests in commercial services, restaurants, hotels and leisure, software, semiconductors, pharmaceuticals and biotechnology, and communications and networking.
- First Round Capital. This is a seed-stage venture firm focused on building a highly-spirited community of technology entrepreneurs and companies.
- Founders Fund. This firm invests in various sectors, including artificial intelligence, aerospace, health, energy, advanced computing, and consumer internet.
Need funding for your small or startup business? Contact PIRS capital today, and we’ll provide the cash flow solutions for you!