Every thriving company has a founding story behind them. Usually it involves college dropouts, friends experimenting in a garage or products sold individually. It makes us wonder how they achieve it. Their success is connected to their passion, perseverance, innovation and usually just being lucky. But the important role venture capital plays in the founding of a company doesn’t usually get told.
The money provided to startups in exchange for partial ownership in a business is called venture capital. It helps in changing the direction and potential of the company. Nowadays, it is a necessary in part in industries for changing a good concept into an organization. Raising of capital is inbuilt with risks for capitalists. Usually, these firms invest in a wide range of budding businesses, so that even if some companies broke up, the high return rate of a single thriving venture can keep them afloat.
Capital comes from various sources and the most common of them are angel investors (rich individuals) and venture capital firms. Entrepreneurs seek capital and venture capitalists provide them for equity. Private investors and investments banks also funnel money to venture capital firms. They depend on these firms to find and fund new companies.
Angel investors have better experience dealing with start-ups. They look up to working with new entrepreneurs. Venture capitalists, on the other hand, are interested in investing in large institutions. They wish to diversify their work portfolio and deal with high risk and high gain investments. Pension funds, insurance companies, university endowments etc place some part of their property in capital funds. They have only indirect control over the capital fund and give fund managers complete flexibility.
The initial stage that a company acquire funding is called early-stage funding. At this point, the company is still a concept which needs capital for basics. It is difficult for such companies to raise capital from normal sources. Companies with little or nil revenue will not attract attention from banks for loans.
For high risk loans, banks usually secure hard assets. As many new companies are technology and innovation based, they won’t have significant assets. Capitalists provide the initial funds for such companies.
Capitalists usually demand direct ownership or management to offset the risk of supporting young companies. These firms also provide services to startups. The capital needed for continued investing is acquired from private firms. To attract them, these firms show their history of successful decisions to such firms. Venture capital firms also expect high revenue from their investments.
Before negotiating a deal, these firms cover every possibilities of success and failure. To safeguard against failure, these firms prefer equity ownership. It helps in return of total investment sum. Co-investing also helps in mitigating failure risk.
Firms can also increase its investment in case of success without paying the market rate.
Money is needed to implement the concepts of young companies. More than half of the invested money is used for infrastructure of a company. Capital firms select high gain and growth industries for investment as they provide easier exiting opportunities. They also look to help companies the firms have experience in, as it allows for good decision making.
Venture capitalists play they role of finding and funding young companies that are unable to borrow from banks. It is a world of start-ups, investors, venture capitalists and investment bankers.