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Understanding Venture Capital

Understanding Venture Capital

Venture capital is a special type of investment that is typically available to small scale enterprises and businesses that have the potential to produce significant long term capital.  This is a high risk endeavor, but the potential for the startup company to generate long term revenue makes venture capital a lucrative investment option for wealthy investors.  

What are some types of venture capitalists?
An adventure capitalist may take even riskier investments.  Predictably, these sorts of investors can be difficult to find.  Adventure capitalists tend to invest out of the excitement implied in risky investing, although many investors will avoid these risks.
An angel investor provides the initial funds to start up a business.  These initial funds represent the seed money available to the business to being operations and seek other venture capitalists to fund the enterprise.  The angel investor is typically close the founder or owner of the startup business and may be focused less on long term returns and will be more invested in having the business succeed.

What are the characteristics of companies that should seek venture capital?
The prime candidates for venture capital are high technology companies, such as software developers and biotechnology firms.  In these high technology fields, a new invention or technology could potentially generate millions of dollars of revenue, often with little capital required.  This differs from other businesses that may need to make a significant capital investment in order to commence operations.  Remember that only a small percentage of companies will receive venture capital, so the startup must be able to prove that they have an innovative idea that distinguishes them from all others currently in that field.  Venture capital seeking firms should be unable to attract funding on public markets and will not be large enough to secure a loan or line of credit from a bank.

What does a venture capitalist do after providing funds?
This will generally be a question to be answered before the funds are provided to the firm.  Venture capitalists will typically demand a high degree of control over their risky investment and will be inserted onto the board of directors for the company.  An investment into a venture capital enterprise means buying a stake in a company, which is different that financing a loan which only entitled the lender to interest.  This gives the venture capitalist the right to influence the direction of the company.  For some firms a venture capitalist with experience in the field or a related field will serve as a reliable asset to predicting market trends and influencing the conceptualization and design of the idea in a manner that makes it more marketable and 

How does one find a venture capitalist?

There exist a number of organizations of venture capitalists that connect these investors to small firms that require investment.  The National Venture Capital Association is an example of one such organization.  When one attempts to find venture capital, they should assess their business model and unique ideas they may have that will be attractive to venture capitalists.  Most venture capitalists will not agree to the risk of investing unless they believe that the idea or business model is unique, even if there is high risk assumed by the venture capitalist.
Venture capitalist firms are structured with venture capitalists, who are general partners contributing money to a venture capital fund.  There are also limited partners, representing foundations, pension funds, wealthy individuals and sovereign wealth funds that contribute to the venture capital fund.  The fund us a limited partnership and that portfolio will contain investments in several startup and other venture capital enterprises.  The venture capital enterprise can be limited in scope, geographic area and investment philosophy.  When seeking a venture capitalist firm, assess the goals of the firm and if those goals are consistent with the goals of the startup company.  A venture capitalist firm in the right industry can boost the credibility of a start up with expertise that may help improve the product and facilitate the company going public.

How does the venture capitalist process work?
There are six venture rounds generally used to assess the stages of a company’s development
Seed money – the initial money, usually provided by an angel investor to prove that the idea is feasible.  This is the minimal level of financing for the company to operate.
Start-up – the company that wants to market or develop the idea can market and begin to market the product.  This is the point where venture capitalist funds become available to further develop the idea to attract further investment.
First Round – the earliest prototype is developed, manufactured and maybe even sold.  The idea now has a tangible form, or in the case of software, the program is now somewhat functional.
Second Round – companies that are selling their product but have failed to make a profit.  The venture capitalist may recognize the potential for the product to make a profit, either through better financing or modifications to the product.
Third Round – this is money provided for the company to expand.  The company has reached a level of profitability and merely requires additional capital to increase its long term prospects.  This is called mezzanine financing
Fourth round – this is called bridge financing and the funding helps to facilitate the transition of the company to eventually become traded publically.

What happens after a venture capital enterprise is successful?
Once the private equity in a firm is sufficient to generate the enormous anticipated revenue, the venture capitalist may be paid back in full plus generous payments and the firm can become a publically traded company that continues to innovate and grow.  Alternatively, the advancement can be bought out by a larger company and the firm that received the venture capital will sell the rights to their idea or invention for enormous.  Those that benefit from selling off the firm may become venture capitalists themselves, or use the earnings as seed money for another venture capital seeking enterprise.  The firm can also merge with other companies that require the expertise or specific invention and create a partnership to seek additional capital or devise ways to market the invention.