Venture capital is a type of private equity funding that is offered by venture capital companies or funds to budding startups, mid-stage, and emerging larger companies that have proven to have very high potential for growth or that have shown extremely high potential for initial public offering ( IPO ) valuation. This type of investment is considered to be highly speculative by most bankers and brokerage firms because the timing and amount of such offerings can be very volatile. An IPO typically follows a standard business cycle in which the company generates growth in product markets, raises money from investors, pays dividends to stockholders, and then eventually decides to sell its stock for proceeds. Many people feel that an IPO is similar to the evolution of a small corporation that becomes larger year after year, until it reaches a point where it can no longer do business without diluting its ownership position or controlling its stock price. However, these views are generally misinformed, as IPO funding is designed to reward early investors who have provided substantial amounts of money to the company, rather than simply enriching the largest numbers of investors overall.
The primary purpose of venture capital is to provide working capital to early-stage businesses through borrowing funds from investors. The purpose of this borrowing is to assist the company in rapidly raising the needed funds to hire employees, make large investments in technology and other tools, and obtain needed equipment for growing the business. It is typically not designed to provide significant long-term liquidity, although venture capital firms typically do provide lines of credit to their clients that may enable them to fund short-term business ventures and repay them in a relatively short period of time.
Venture Capitalists typically seek to make their investments with funds from relatively institutional investors, as opposed to early stage angel investors. The reason for this is that institutional investors typically control a large portion of the total value of a given business, meaning that they can exercise greater control over a given startup than an individual investor would. Also, when a venture capital firm makes an investment, it issues an ‘asset’ – a promise to return a certain amount of money at a future date. Because the startup has not produced concrete business plans or obtained any government funding, most venture capital firms will not provide any guarantees on the money received.
Venture capitalists typically seek to partner with new businesses that are in strong financial position – operating profitably and with significant market potential. However, there is no guarantee that a new business will be successful in the first years to come. The reason for this is that there are no guarantees in venture capital. This is contrast to traditional venture capital, which is based on assumptions of success in return for a significant risk in capital investment. The potential for risk in new businesses is what causes the difference between venture capital and traditional venture capital.
There are different methods that venture capitalists use to assess a business’s likelihood of success. An objective evaluation of a company’s strengths and weaknesses is used in the context of seeking to raise additional capital. Based on the information gathered, a proposal to investors is created and either funded or evaluated in terms of relative likelihood of success and return on investment. Venture capitalists assign a score to these proposals to quantify their value. This score is publicly available and can often be obtained by contacting the individual who provided the initial funding.
In order to receive equity capital, a startup must demonstrate the ability to generate the type of return on investment that the venture capital investors are looking for. In general, most investors will only invest their own personal funds into new businesses. Since most private investors typically have limited experience in the business world, they are usually looking for a business with substantial potential for growth. Typically, private investors will provide seed money and do not expect to receive a return on their investment until later. However, because these investors typically have a strong background in the business world, they are more likely to invest in companies that are positioned to benefit from their past investments.