Venture capital (VC) is a type of financing provided by investors to startup companies and small businesses that are thought to have long-term growth potential. Venture capital is typically provided by wealthy investors, investment banks, and other financial institutions
How Does it Work?
Venture capital financing is funding provided to companies and entrepreneurs. It can be provided at different stages of their evolution, although it often involves Pre-Seed, Series A, Series B, Series C with all comes with different type of milestone that the entity which are being invested to had to achieve to get on with the next funding.
It does not, however, always take monetary form; it can also take the form of technical or managerial expertise. Venture capital is typically allocated to small businesses with exceptional growth potential, or to businesses that have grown rapidly and appear poised to expand further.
Though it can be risky for investors who put money up, the potential for above-average returns is appealing. For new companies or ventures with a short operating history (less than two years), venture capital is becoming a popular—even critical—source of funding, particularly if they lack access to capital markets, bank loans, or other debt instruments. The main disadvantage is that investors typically receive equity in the company and thus a say in company decisions.
Advantages And Disadvantages of Venture Capital
Venture capital is used to fund new businesses that do not have access to stock exchanges and do not have enough cash flow to take on debt. This arrangement can benefit both parties: businesses get the capital they need to get started, and investors get equity in promising companies.
A VC investment has additional advantages. VCs frequently provide mentoring services to help new companies establish themselves, as well as networking services to help them find talent and advisors. A strong VC backing can be used to fund additional investments.
A company that accepts VC funding, on the other hand, may lose creative control over its future direction. VC investors are likely to demand a large share of the company's equity, and they may also begin to make demands on the company's management. Many VCs are only looking for a quick, high-return payoff and may put pressure on the company to exit quickly. In the end, there is trade off to anything and it’s up to the founders to take the opportunity.
Venture Capital Process
The first step for any business looking for venture capital is to submit a business plan, either to a venture capital firm or to an angel investor. If interested in the proposal, the firm or the investor must then perform due diligence, which includes a thorough investigation of the company's business model, products, management, and operating history, among other things.
Since venture capital tends to invest larger dollar amounts in fewer companies, this background research is very important. Many venture capital professionals have had prior investment experience, often as equity research analysts; others have a Master in Business Administration (MBA) degree. Venture capital professionals also tend to concentrate on a particular industry. A venture capitalist that specializes in healthcare, for example, may have had prior experience as a healthcare industry analyst.
Once due diligence has been completed, the firm or the investor will pledge an investment of capital in exchange for equity in the company. These funds may be provided all at once, but more typically the capital is provided in rounds. The firm or investor then takes an active role in the funded company, advising and monitoring its progress before releasing additional funds. The investor exits the company after a period of time, typically four to six years after the initial investment, by initiating a merger, acquisition, or initial public offering (IPO).
Success Story
The famous cab services Uber was able to raise a staggering $1.5 billion in venture capital funding. The company raised $1.2 billion in funding back in 2014 from a group of mutual fund managers and venture investors, including Fidelity Investments, Wellington Management, and BlackRock Inc. Uber was also able to raise an impressive $258 million from Google Ventures. The company isn’t just good at helping users hail cabs, it is also pretty good at raising money.
This popular photo-sharing app in which photos disappear just seconds after they’re opened was created by former Stanford students Evan Spiegel, Bobby Murphy, and Reggie Brown. The app isn’t just tremendously popular with the youth of America — it’s also popular with venture capitalists. It raised close to half a million in an initial seed round, and later raised 60 million in a funding round led by venture-capital firm Institutional Venture Partners. All in all, it has raised a staggering $486 million in investments. In February of 2015 Snapchat announced another round of funding, in which it raised a staggering $1.4 billion.
This online mobile photo-sharing and video-sharing site was developed in San Francisco by Kevin Systrom and Mike Krieger. In a little under a year and a half, it garnered over 100 million users, and quickly attracted the eye of many venture capitalists. Instagram raised $7 million in Series A funding from several different investors, including Benchmark Capital, Jack Dorsey, Capital fund, and Adam D’Angelo, which put the company at a value of $25 million. In a subsequent round of funding, they raised $500 million from venture capitalists, putting the company value around $25 million. Social media giant Facebook ended up purchasing the company for an impressive $1 billion dollars.