Venture Capital and Other Types of Investing
Venture capital is a type of private equity funding which is provided by venture capital companies or funds and is usually offered to startups, early stage, and emerging businesses which are deemed to have good growth potential or that have shown consistent growth over a certain period of time. Venture capital companies generally fund these kinds of businesses as a means to provide seed financing to allow them to develop their business or to raise additional capital to expand their existing business. Venture capital funds typically invest in a smaller number of these kinds of businesses compared to other types of private equity funding, although the overall investment may be higher due to the lower risk associated with these kinds of investments.
The primary drivers for venture capital funding are generally angel investors. Angel investors are wealthy individuals who often give new businesses investment capital so they can continue to develop and increase their business’s scope. Many times, venture capitalists are provided a certain percentage of the proceeds from a private equity deal so they can have an interest in these emerging companies. An objective investor would look at these companies in a more favorable light, providing greater liquidity and a good exit strategy for the company.
For an investor to acquire this kind of financing, they will need to be an accredited investor, meaning they must have purchased a certain amount of the shares of the business that you want to invest in through a traditional capital route such as a conventional loan from a bank or a broker. Other investors will want to invest money in a startup only if they believe that the company has great opportunity for growth and will therefore experience substantial profits in the future. Venture capitalists will often require a significant upfront investment in order to obtain the loan, but it can also provide greater long term flexibility on the part of the investor.
Venture capitalists can either provide the money independently or as part of a portfolio of investment properties. In the case of independent funding, an individual investor will take the risk and provide the capital as needed. The greatest benefit of venture capitalists is their ability to provide a higher rate of return for high risk investments. If a startup fails and no additional funds is available to continue operations, a venture capital fund will often absorb most of the loss and current assets of the company to recover some of its investment. There are many successful stories of venture capitalization where very small amounts have been invested in startups that later turned a profit, later becoming large cap or blue chip companies.
institutional investors are a different story. They typically purchase more shares or stock of a company than a private investor would, in order to participate in the company’s profits. For example, pension funds generally own a large chunk of any given company’s stock. If the company becomes unprofitable, the investment made by the pension fund may be lost. As a result, venture capital investors can potentially “seize” this pension fund’s investment in order to increase their own returns.
Private angel investors and venture capitalists are typically much more hesitant to take a risk on new businesses. It is also difficult to find partners that are ready to invest large sums of money in new business ventures. Most entrepreneurs prefer to raise money from a group of friends or family members. These investors must commit to investing large sums of money and providing a substantial amount of personal guarantees to secure the loans. This group of friends and family members are also unlikely to want to take a risk on an unknown business.
