What is ‘Venture Capital’?
Venture capital is financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. For startups without access to capital markets, venture capital is an essential source of money. Risk is typically high for investors, but the downside for the startup is that these venture capitalists usually get a say in company decisions.
Breaking Down ‘Venture Capital’
Venture capital generally comes from well-off investors, investment banks and any other financial institutions that pool similar partnerships or investments. Though providing venture capital can be risky for the investors who put up the funds, the potential for above-average returns is an attractive payoff.
The Venture Capital Process
The first step for any business looking for venture capital is to submit a business plan, either to a venture capital firm, or to an angel investor. If interested in the proposal, the firm or the investor must then perform due diligence, which includes a thorough investigation of the business model, products, management and operating history, among other things. Once due diligence has been completed, the firm or the investor will pledge an investment in exchange for equity in the company. The firm or investor then takes an active role in the funded company. Because capital is typically provided in rounds, the firm or investor actively ensures the venture is meeting certain milestones before receiving another round of capital. The investor then exits the company after a period of time, typically 4 to 6 years after the initial investment, through a merger, acquisition or initial public offering (IPO).
There are five common stages of venture capital financing:
1) Seed stage
- Convince the investor why the idea/product is worthwhile
- Technical and the economic feasibility (Feasibility Study) of the idea
2) Start-up stage
- A management team is being formed to run the venture
- Clients are being attracted for initial sales.
- Establishes a feasible production line to produce the product.
- Market research to see whether the market size is big enough
- Create a realistic forecast of the investment needed to push the venture into the next stage
3) Second stage
- The idea has been transformed into a product and is being produced and sold.
- Trying to squeeze between the rest and it tries to get some market share from the competitors
- Trying to minimize their losses in order to reach the break-even
- The management team is proven their capability of standing hold against the competition
4) Third stage
- The expansion/maturity phase of the previous stage
- Tries to expand the market share they gained in the previous stage
- Cut down their production cost or restructure the internal process
- Starts to investigate follow-up products and services
- Investigates how to expand the life-cycle of the existing product/service
5) Bridge or re-Initial Public Offering (IPO) stage
- The venture to go public so that investors can exit the venture with a profit commensurate with the risk they have taken
- Achieves a certain amount of market share.
- Introduce the follow-up product/services to attract new clients and markets
- Occasionally made a very successful initial market impact and been able to move from the third stage directly to the exit stage