When someone starts a new business, they need funds to get it off the ground. They need money to purchase or rent a workplace, supplies, furniture, equipment, hire employees, invest in marketing, etc. A new business can get this money from several sources: personal savings, bootstrapping, bank loans, etc. however, all these techniques have restrictions unless the owner is already a rich individual. Another way to get money for business is Venture Capital. This funding option sometimes makes large sums available, helping a company with its start-up expenses or funding its growth very quickly. The start-up funding segment has more money than ever across different funding stages.
Even though the capital markets keep changing worldwide, the VC fundamentals remain broadly unchanged. Here, we break down what Venture Capital is, how it works, and provide VC support to explain everything one needs to know.
What is Venture Capital?
Venture Capital is a type of private equity through which investors provide financing to start-ups and SMEs with high potential for long-term growth. VC investors often include investment banks, financial institutions, and well-off VC firms. However, apart from monetary assistance, VC investment usually also consists of the managerial and technical expertise of the investors. Investors often invest in companies with extraordinary growth potential or businesses that have grown very quickly and continue to expand.
Although investing money in a start-up is risky for investors, the prospect of above-average return is a lucrative payoff. New companies with a short operating history find Venture Capital an attractive funding option to raise money, particularly if they have low access to bank loans, capital markets, and other financing instruments. Investors, besides getting equity in the start-up, also provide VC support to influence company decisions.
How Does Venture Capital Operate at Different Stages?
As a company grows, it goes through various Venture Capital stages. Investors or VC firms might focus on particular stages while investing, significantly impacting their decisions.
Seed Stage: In the seed round, the investor provides relatively small amounts of capital to a start-up intended for its market research, business plan development, and product development. It is often a company’s first round of getting institutional funding. Seed investors often get convertible notes, preferred stock options, or equity in the company in return for their investment.
Early Stage: Companies in their development phase seek Venture Capital funding in the early stage. It usually involves a larger amount than the seed round because once established, the business needs more capital to start its operations, market products or services, explore more markets, etc.
Late Stage: Late stage VC support is for more mature businesses that have earned or not earned profits yet but have generated revenue and proven growth over the years. If the company receiving the investment goes public or gets acquired, it makes profits and distributes it among its limited partners. The firm can also earn profit by selling its shares to other investors in the secondary market.
Working of Venture Capital
Unlike angel investors who invest their own money into the business, venture capitalists work for VC firms that raise finance from external investors. These investors are limited partners and include family offices, institutional investors, insurance companies, pension funds, and high-net-worth individuals. They use VC support to invest money in businesses with an impressive growth history or high growth potential. Some VC investors invest in companies at any stage of their lifecycle, while others stay focused on certain stages. Some investors also specialize in supporting particular industries or verticals.
Apart from obtaining large capital amounts, companies also add value to their business by leveraging the skills, connections, and experience of VC investors. After the VC investment, the investors usually join the board by becoming official board members or board advisors. That way, they get involved in the business’s strategic and operational decisions and help it become successful.
Venture capital investments represent central parts of businesses’ lifecycles. Before earning any revenue, a company needs money to rent facilities, hire employees, design, produce and market products, etc. With expert-backed VC support, investors identify start-ups with high growth potential and invest money in them to get their equity. Besides investing in a new company’s broad portfolio, VC investors leverage their networks and provide hands-on guidance to set the new firm for success.
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