Venture capital is the name given to the financial capital provided to young, startup businesses which investors, known as ‘venture capitalists’, predict to be highly profitable in the future. It is technically a subset of private equity, albeit with significant differences in approach, structure and risk.
A venture capital fund is the investment vehicle which specialises in these high risk, high return transactions. Venture capital is generally focused on industries like technology, bio-tech and pharmaceuticals, with the funds acquiring minority stakes of equity in a pool of different businesses, in exchange providing the vital capital and expertise that these entrepreneurial ‘ventures’ need to grow.
The amount of venture capital provided to such businesses typically falls in the range of $5-20m. This is unlike private equity, where deal sizes can range anywhere from $10m to well over $100m, with the fund acquiring 100% of the business. Venture capital funds generally invest only equity, unlike private equity funds, which use combinations of equity and debt to leverage their stakes.
Any venture capital definition would, of course, be incomplete without detailing how the process works in practice. So, let’s get to it.
There are generally five stages of venture capital financing. These are:
• The Seed Stage
The seed stage is the influx initial capital required to get the business off the ground. The business in question is generally at the pre-revenue stage of its lifecycle, perhaps still generating ideas and exploring markets. It is a high-risk investment, requiring a great deal of confidence in the founder’s ability to make the business a success.
• The Startup Stage
If the idea and business process is deemed to be worthy of success, venture capital funding will move to the next stage. The venture capital firm will want to see a detailed business plan, often including market research, and the firm may be starting to generate sales. A board of directors is formed and, at this stage, it is common for a venture capital fund member to sit amongst them in a management role to ensure its success.
• The First Stage
At this stage, the concept of the product or service is launched in earnest and should start to generate revenues. The company endeavours to increase its market share and minimise its costs in order to at least break even. If the VC fund is confident in the company’s management, they will generally give the go ahead for another round of funding. If not, they will look to restructure the board or implement another idea to turn the company around. If problems cannot be resolved, then they will look to withdraw their investment.
• The Second Stage
The second stage is seen as the expansion or maturity stage. The company will now be established in the market and be looking to expand, either through the launch of new products or scaling up marketing efforts. Management will still look to minimise costs during this scaling, in order to achieve a profit and gain yet more funding from the venture capital fund.
• The Bridge Stage
In the final stage of the venture capital financing process, the VC will be looking to exit from its investment, having pocketed a healthy profit. By now, the venture should have a large enough market share to consider a range of exit options for the stakeholders, from listing its shares on the public market to acquiring or being acquired by other companies. The venture capital fund will provide its expertise and look to sell its shares in the venture, before beginning the investment process again in another, younger company.
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