Venture Capital and Angel Investor Backgrounds
Venture capital is a type of private equity funding that is usually provided by venture capital funds or individual investors to emerging or growing businesses that are deemed to have medium to long growth potential, or that have shown great promise in the technological or economic fields. Venture capital funds are normally intermediaries between startups and angel investors. The role of these funds is to provide seed funding to startups on condition that the startups agree to share their proprietary technologies or business processes so that the fund will benefit from the startup’s future revenues. If the company becomes successful and generates substantial revenues, then the investors can receive a portion of the proceeds. However, if the company flops, there is very little if any of the investor’s money that was invested.
Investing in Venture Capital is a relatively new concept. Prior to the advent of venture capital, most private equity and large cap investment programs were directed at industrial, financial, or venture capital firms that typically operate in different stages. Venture Capital firms today typically invest in either technology companies with which they have long relationships or new companies whose products and/or services appeal to a more niche market. Venture capitalists usually seek to acquire companies in different stages of development as it is more difficult to successfully fund an emerging company in the initial public offering (IPO) stage due to the lower barriers to entry for private investors.
Venture Capitalists work in pairs or teams; two investors may be involved in a deal while one investor acts as an intermediary between the venture capital firm and the prospective commercial investor. While some venture capitalists work solely as brokers who facilitate investments between various funding sources, many others are actively involved in the companies they fund. As such, these firms need to be capable of navigating the often complex and specialized structure of venture capital funding. Because of this, they often seek to retain the services of an outside executive finance management team to act as an intermediary between them and the company’s management.
In addition to facilitating and managing venture capital funding, the investment banker also takes a vested interest in the company being funded. As such, he or she will likely be involved in discussions about management and board appointments, financing options, management policy, and P&L. While these conversations may seem mundane, they are critical to a successful outcome of any venture capital funding round. An investor needs to feel comfortable with the investment banker as he or she represents the future owner of the business.
Private pension funds and other major institutional investors typically do not invest in small cap or high growth companies. As such, they are not necessarily familiar with the details of how to evaluate companies for either an initial public offering (IPO) or a subsequent private placement. In some cases, the investment banker can serve as a mediator between these two parties. By providing investment direction and contacts from the largest private equity and venture capital investors, the investment banker can help these institutions gain greater understanding of what they can expect from these companies during the life of the financing program. Additionally, these executives can provide advice concerning exit strategy and the marketing of company shares to the secondary market.
There are many reasons why an investor may seek to work with a venture capital firm. Because this line of credit is often associated with higher risk, most angel investors prefer to invest in smaller, high potential cap companies rather than larger, more established ones. As such most private investment firms prefer to partner with angel investors rather than venture capitalists. Nevertheless, both groups have advantages and disadvantages and should be considered carefully when deciding where to invest and when to do so.