Venture capital (VC) is the type of financial capital that is provided to high potential, early stage, high- risk growth start up companies. The venture capital fund normally gets money through owning equity in the company it has invested in. The business usually has a business model in high technology organizations or novel technology in industries such as software, IT and biotechnology. It is also considered as private equity as it is a subset of this. H
owever it is important to note that not all private equity is known as VC. This type of capital is ideal for companies that are just starting out without a lot of history and cannot afford to raise capital via the public markets and can also not complete debt offering or secure a bank loan.
Generally, venture capital is made as cash that is exchanged for shares in the investment company as well as an active role in the company. This differs from other traditional financing sources in the sense that:
- It mostly focuses on high growth, young companies;
- Rather than investing in debt, it invests in equity capital;
- It takes higher risks that are exchanged for potentially higher returns;
- Has longer investment horizon when compared to traditional financing options;
- The portfolio of the company is actively monitored through strategic marketing, board participation, capital structure and governance.
Equity capital is one of the things that determine the long term growth of most businesses. Lenders normally ask for some collateral (security) before they can release their money to small businesses. If a company does not have security, their debt financing is limited in a huge way. In addition to this, debt financing normally requires current interest payment that are used to service the debt. This means that the funds cannot be used to grow the business. Venture capital comes in to offer businesses a financial cushion.
The capital is something long term also known as “patient capital” as it gives the companies time to grow into something profitable. Investors who offer this capital normally offer unsecured capital by assets to private young companies. It is an active form of financing. In addition to capital, investors also seek to add value to the companies in a bid to help them grow fast so that in the long run they can get better returns on their investment. This normally requires participation in the running of the company, where most capitalists normally want a seat as on the board. Despite the fact that they are in for the long haul it does not mean that the capitalists will remain with the company indefinitely. A good investor normally has a sound potential exit strategy from the time he/she gets into the business.
Capital venture process
The companies that are looking to benefit from this type of capital should expect to go through the following process;
Draw up a business plan and submit it
Your business plan will be reviewed by the investor to know if it is worth investing in. Most funds normally concentrate on the industry you want to get into, stage of development and geographical area among other things to find out if you meet the fund’s investment criteria.
Due diligence is performed on the small business if the venture fund is interested in the investment. This includes studying in detail what the business is all about including product& services, management team, operating history, market, financial statements and corporate governance documents. At this point, a term sheet can also be developed which will describe all the terms and conditions under which the investment will be made.
Once this is done and the venture fund is still interested, an investment will be made to the company in exchange for some of its debt and/or equity. The performance of the company normally determines the terms of the investment. This offers great benefit to the businesses and also minimizes the risk for the investor.
Execution with VC support
As soon as the fund has been invested, it allows the investor to get actively involved in the organization. This helps the company as it executes its plan to grow by pumping in money in “rounds” rather than once as the business meets its previous milestones that were agreed upon.
On average the venture funds normally want to spend around 4- 6 years before they exit. This is how they make money as it is normally done through IPOs acquisitions and mergers.