Understanding Venture Capital Investments

venture-capitalApproximately $58.8 billion was deployed through venture capital in 2015, according to the National Venture Capital Association (NVCA). Here are ten of the most common questions about seeking and obtaining venture capital.

#1: Who are venture capitalists?

Venture capitalists (VCs) are investors that provide temporary equity financing to young startup companies deemed to show the potential for long-term growth. Funds are provided until the startup is both large enough and credible enough to be sold or issue an initial public offering (IPO).

Because VCs can expect most startups to fail or break even, they seek high rates of return on their investments.

#2: Where does venture capital originate?

Sources of venture capital include wealthy investors, banks, and pension funds that set aside a small portion of their money for risky investments.

#3: What is a venture capital firm?

Venture capital firms are made up of two types of partners:

General Partners: The financial experts, possibly former entrepreneurs, who set up the funds, decide on how small or large the funds will be, and make investment decisions.

Limited partners: Investors who commit money to the funds.

#4: Why do companies need venture capital?

A startup has a limited operating history which makes it difficult to obtain loans. Venture capital is a temporary source of funding to help grow the company.

#5: What role do venture capitalists play in a startup?

In addition to the financial investment, most VCs are actively involved in the startup, often taking a seat on the board of directors. They give strategic advice, help with recruitment, and introduce future customers or partners. They also provide assistance during the IPO or sale of the company.

#6: What does the venture capital process look like?

VCs consider factors such as the size of the market, timing of the startup, growth potential, and ability to exit.

First step: The founder submits a business plan to a venture capital firm.

Second step: If the venture fund is interested, it performs due diligence which includes an investigation of the business model, product, management, operating history, and financial statements.

Third step: The firm pledges an investment in exchange for equity in the company and the terms are defined.

Fourth step: Capital is disbursed in rounds after certain milestones are met.

Fifth step: After a period of 4-6 years, investors exit through mergers, acquisitions, or initial public offerings (IPOs).

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