Venture capital is basically a type of private capital financing which is given by private venture capital firms or private funds to early-stage, startup, and emerging small businesses that have been deemed to possess high initial growth potential or that have proven earnings potential. Typically, venture capitalists provide venture capital financing in the form of shares of stock in the business. In this way, they participate in the equity value of the company and thus indirectly owning a significant amount of the business.
Venture Capital firms typically seek out startups in the consumer or technology sector. These companies will typically present an appealing business model and strategy to funders which are based on strong assumptions and a business plan with a substantial number of its own components. Venture Capital firms then evaluate these plans and expect to provide seed financing for these ventures if they are considered to be high risk or “untouchable.” Unquestionably, there are times when these types of small businesses will not receive the level of attention or financing they require to make an exit.
However, for many of the more highly successful venture capitalists, it’s not always a simple story. In some instances, the outcome of a given funding effort may not be so favorable. This is particularly true of those efforts which are round. Investors who lack the experience with this type of financing may also lack the skills necessary to assess the risks of such an investment and therefore may under-capitalize and therefore lose a lot of money. There are also some entrepreneurs who do not see the point of this type of investment as it is viewed by venture capital groups.
In terms of evaluating the attractiveness of Venture Capital, some of the major areas of focus for venture capitalists include valuation and liquidity. Venture Capitalists attempt to determine the value of a company based on its market capitalization or the price per share which is generally the measure of a company’s market value. Many investors also evaluate the liquidity of a company in terms of its cash flow. While this measure is considered relative to its industry peers, most venture capitalists will view liquidity in terms of future earnings from the sale of equity as a more relevant measurement of value. Valuing and Liquidity should therefore be kept at a fairly high priority in terms of investment considerations.
Venture Capitalists will also consider many other factors which are outside of the scope of this discussion, but are nonetheless relevant to the overall investment strategy and decisions made by venture capital groups. One such factor which should be considered is the level of risk which an investor is willing to tolerate. Venture Capitalists typically fund very early in the life of the small business investment. Therefore, they are at a greater risk of losing their investment during the earliest stages of growth due to high risk specific to that type of business.
The final area which should be examined within the context of venture capital is the level of disclosure which the companies need to provide to potential investors. Most private investors will be reluctant to invest in a high-risk, speculative business because of the inherently higher risks associated with such investments. Venture Capitalists tend to fund more established companies in order to obtain a significant return on their investment.