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A Venture Capitalist purchases a stake in an entrepreneur’s startup and helps fund and cultivate the company into a successful corporation.
Venture Capitalists invest in burgeoning industries that are on a clear upswing, such as tech, SEO and biotech companies. They tend to invest in companies in the middle stages—after the shaky, risky early phase yet before the soaring, competitive phase.
An entrepreneur with a growing, robust company is most likely to attract a solid Venture Capitalist. Loans can only get an entrepreneur and a company so far, and the plethora of risks in a startup means high interest rates.
“Venture capital fills the void between sources of funds for innovation (chiefly corporations, government bodies, and the entrepreneur’s friends and family) and traditional, lower-cost sources of capital available to ongoing concerns. Filling that void successfully requires the venture capital industry to provide a sufficient return on capital to attract private equity funds, attractive returns for its own participants, and sufficient upside potential to entrepreneurs to attract high-quality ideas that will generate high returns. Put simply, the challenge is to earn a consistently superior return on investments in inherently risky business ventures.”
- Bob Zider
Venture Capital investors are usually large financial firms, university endowments and insurance companies. A small amount of these companies’ overall funds are put into high-risk Venture Capital investments, with an expected return of 25% - 35% annually over the course of the investment.
However, Venture Capitalists seek more than a mere investment on paper; they want to invest in smart, engaging entrepreneurs with a solid team behind them; an experienced, capable Board of Directors and a young but successful, growing company.
Entrepreneurs who have a proven track record as startup founders are more likely to attract experienced Venture Capitalists, since typically they prefer to invest in skilled, effective people.
To a certain extent, Venture Capitalists invest in a company’s management as much as in the company itself; that is, since they tend to invest in industries with superior growth rates, the risk is attached to the Board of Directors and its ability to steer the company toward continued success and progress.
Venture Capitalists tend to take their profits and exit a company while it’s on top, before it gets too big, so they earn excellent returns and find another industry and company in which to invest.
If the company does extraordinarily well earlier than expected, Venture Capitalists can often increase their investment, at the earlier, below-market price, and thereby reap even greater rewards.
Venture Capitalists can also choose to pair up with other Venture Capitalists, thus hedging their bets. Usually one will be the lead investor and the other (or others) will follow along.
Source: Zider, Bob. “How Venture Capitalism Works.” Harvard Business Review. November/December 1998.
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