What is venture capital?
Venture capital is an equity investment that provides funding for early-stage companies with the potential for long-term growth. It’s a source of financing typically used to raise capital for companies without credit, operating history, or collateral to garner a traditional loan from a bank.
Venture capitalists perform due diligence, which includes a thorough investigation into the management team, products, history, financial statements, and business model of the venture before investing. The size of venture capital investments can vary, but they typically range from a few hundred thousand to millions.
Venture capital sources include dedicated venture capital funds, institutions such as pension funds, and wealthy individuals known as angel investors. Venture capital funds are set up as limited partnerships. For example, a management company starts with its own money, raises additional funds from limited partners such as pension funds, then invests this capital in various start-up companies.
The management company usually takes a significant equity stake in the start-up company they invest in and take an active role in the management of the firm, helping recruit senior managers, providing business advice, and sometimes playing a leading role in the activity and operations of the business. The management company charges a fee for overseeing the VC investments. After some period, 10 years for example, the fund is liquidated either through an IPO or a strategic sale, and the proceeds are distributed to the investors.
Stages of funding
- The first financing stage is the seed stage, where the venture capitalist provides the initial capital to get the company off the ground.
- The second stage is the early stage, where the company starts to generate revenue but is not yet profitable.
- The third stage is the expansion stage, where the company begins to scale and generate significant profits.
- The fourth stage is the late stage, where the company is mature and generates large amounts of revenue.
- Finally, the fifth stage is the exit stage, where the venture capitalist exits the company by selling their equity to another investor.
Venture capitalist funds typically invest in startups that are in the early stages of development, such as the seed stage or Series A stage.
In conclusion, venture capital is a method of financing for early stages or expanding businesses that have limited access to other forms of financing. Conventionally, venture capital funds were managed by venture capitalists with substantial investment experience. However, nowadays, many venture capital funds have a professional management structure.