Venture Capital Definition
Suppose you have a startup business and cannot get a bank loan or line of credit. In that case, you may look for venture capital funding.
Made famous from television shows such as "Shark Tank" or "Silicon Valley," venture capital funding has been around for decades.
Startups and early-stage companies are risky investments, many fail. Therefore, it is difficult for these companies to secure bank loans. Additionally, new companies start small. So they cannot raise capital funds by selling shares of stock or initiating a public offering.
However, another option to raise money for your business is from a venture capital investment.
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What is Venture Capital?
Venture capital is an equity investment made in a startup company. The investor provides capital (money) in exchange for a part of the company ownership (equity). The investment provides capital for startup operations or the growth of an existing company.
Understanding Venture Capital
Types of Venture Capital Investors
There are two types of venture capital investors: venture capital firms and angel investors.
- Venture Capital Firms. A venture capital firm is a financial organization or institutional investor that can make large capital investments. They also provide industry expertise and management.
- Angel Investors. Angel investors are wealthy individuals. Some have vast business knowledge. And others simply provide money in exchange for equity in your company. Angel investors may or may not participate in your business activities. Some angel investors can handle investments of a few million dollars. However, institutional investors make more significant investments.
How Venture Capital Works
There are many stages for venture capital funds: startup, development, maturity, and growth. The venture capital firm evaluates your company and provides money and expertise. In exchange for their investment of time and money, they take a part of your company.
Advantages of Venture Capital
- Capital for Your Company. The primary advantage of a venture capital investment is getting money to run and expand your company. If you cannot obtain bank financing or loans, a private equity investment is an option to keep your company going.
- Expertise. The venture capital partner may also provide advice, a help network, and make connections to benefit the company. Venture firms have an extensive network of people with expertise. Some venture capital firms specialize in one industry, for example, digital technology.
Disadvantages of Venture Capital
- Gives Up Equity. The main disadvantage to a private equity firm investment is giving up a percentage of your company. Giving away 25% may not seem like much for a new company that is not making a profit. However, if that company grows and turns a profit, that 25% stake is now significant.
- Acquires a Not So Silent Partner. Additionally, your venture capitalist is now your business partner. They will participate in management decisions, sit on your board, and exert influence. So unless you agree on everything, there is potential for conflicts in management styles and business goals.
- Can Incur Management Fees. The partner may also charge you a management fee for their expertise and supervision.
- Discourages Other Investors. Furthermore, it is challenging to get new financing from other sources if you have already given up shares in your company.
How To Get Venture Capital
The first step is to make a business plan. Investors want to see your business model and how you operate your business. They are particularly interested in your projections for growth since they will share in your profits. Additionally, they want to invest in a company positioned for long-term growth potential to maximize their time, energy, and original investment of private equity funds.
The next step is bringing your equity investor into your company. You form a limited partnership or give a share of your corporation or other business entity.
Venture capital is a great way to finance your business if you can't get bank loans or traditional financing. However, you are giving away a part of your company. Therefore, you want to make the best deal possible. An experienced business law attorney can help advocate your interests and negotiate a favorable deal.
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