Venture Capital Definition
Venture capital is money given by a wealthy investor, investment bank or financial institution to a start-up business to help it develop and see long-term success. In return, the investor gets equity or control in the business. Sourcing venture capital is a beneficial option for companies that do not have the cash flow, collateral or reputation to secure a business loan.
However, venture capital is not always a monetary contribution. Start-up owners could also be in need of technical know-how or managerial expertise to kick-start their business. This can also be provided in exchange for a stake in the business.
Investors for small businesses and start-ups can take two forms: venture capital firms (which will be discussed later on) and high-net-worth individuals (HNWIs), also known as angel investors or business angels.
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Venture Capital Definition Business
Venture capital is a type of private equity. While private equity as a whole originated in the 1800s as a way for large business owners to access extra income or relinquish some control of the company, venture capital is a much more recent concept, emerging after the Second World War to enable smaller start-ups to gain an initial investment. Today, venture capital plays a huge part in the UK business scene. It is thought that businesses that have benefitted from venture capital see a combined turnover of £9 billion and contribute almost £5 billion to the gross domestic product, as well as generating the equivalent of just under 70,000 full-time jobs (Oxford Economics & BVCA, 2017 and the British Business Bank).
Venture Capital Firm Definition
There are specialised venture capital firms that have been set up to facilitate the selling of equity to investors. Most venture capital transactions occur when a large slice of a business is taken and sold to several investors. These investors can then work in independent limited partnerships.
Venture capital firms manage these transactions, taking start-up businesses in search of investment and pairing them with one of the investors who hold shares in the venture capital firm itself. The National Venture Capital Association (NVCA) is a community of hundreds of venture capital firms that champion innovation in new businesses, and more information on venture capital can be found on its website.
What do venture capital investors look for?
Venture capital funding is becoming more and more common among small businesses and start-ups, as many new businesses don’t have the option to raise capital in other ways. But what is in it for the investor?
Of course, many new business ideas never come to fruition and so venture capital investors must accept that the business they finance may not be successful. It can be extremely difficult to predict the popularity and profitability of a brand-new business. However, there is also a chance that the business could take off and generate a high return on investment for any stakeholders.
The main advantage for venture capitalists is the ability to have a say in the company’s movements. Depending on the company, they could do this by being granted a seat on the board of directors or by becoming a consultant for the business. If the business is losing profitability, the investor’s expertise can help to steer the business in the right direction.
How The Venture Capital Process Works
It is rare for venture capital firms to scout out investment opportunities. Usually, businesses in need of capital identify appropriate venture capital firms and contact them with details of their business opportunity and proposal.
The business must then pitch their business plan to the investors. This stage is vital; if the business founders or representatives present a poorly-prepared, convoluted or flawed pitch, they can say goodbye to their dreams of receiving the capital they desperately need to get their business off the ground. The pitch must present the business’ unique selling point and a compelling business model, as well as demonstrate demand for the product or service being sold. Investors should be able to recognise the founders’ ability to develop the product or service, build a strong workforce and attract and maintain customers.
While venture capital funding might seem like an excellent way of gaining money without the burden of paying it back – plus any interest – acquiring this kind of funding is more difficult than it might seem. According to Harvard Business Review, less than one percent of businesses use venture capital funding to build their brand.
If the business catches the imagination of any investors, the process can move on to the next stage. Investors will carry out due diligence on the business owners and the business itself to try to get a sense of the risk factor of the opportunity. If the founders of the business have a good track record or have launched or run a successful business in the past, it will help their case.
If the investor decides to go ahead with the investment, they will pledge their capital to the business in return for equity, and the business can start to take shape.
On average, investment deals of this kind usually take place over four to eight years. After this, investors ‘exit’ the agreement by initiating a merger, acquisition or initial public offering (IPO) in the hope of making a profit on their equity in the business.
Conclusion
Venture capital funding can be a constructive business move for both investors and businesses seeking investment. In order to secure funding, business representatives should ensure that they compile a convincing business pitch that highlights the full potential of the business idea and any other plus points that are worth mentioning, such as a particularly experienced team member or a survey demonstrating market demand.
In order for investors to see a good return on investment, they should undertake in-depth research until they are convinced that they are investing in a business that harbours the potential for profitability and further growth. A venture capital agreement can represent a mutually beneficial relationship that both enables entrepreneurs to realise their visions and affords external investors a steady income and influence in a promising business.