Venture Capital: Why They Matter to the Business World

fundMany entrepreneurs often go after venture capitalists as their major source of financial backing. Venture capital firms are known for supporting companies with a high growth potential in the early stages. In fact, many of the most successful businesses owe their growth to them. Venture capitalists can provide large amounts of money, tips, and prestige – merely by their presence.

If you are successful in obtaining venture capital backing, then it means your business has a considerable potential for profitable growth. VCs make equity investments in young businesses. The loans are usually expensive, with rates reaching up to 20 percent. Most venture capitalists look for very high rates, with a 30 to 50 percent rate of return every year.

Unlike lending institutions and banks, venture capitalists also often accept equity positions. This means you do not have to pay cash in the form of principal installments and interest, but you provide a part of your interest in the business in exchange for the VC’s support.

The catch here is you have to give a big portion of your business to receive the funding. Venture capitalists, in fact, frequently seize most control from founding entrepreneurs and oust them. This is why they are sometimes described as “vulture capitalists.” However, not all venture capital firms are like that, so do not fret.

Venture capitalists often invest in businesses that they believe will be sold either to larger firms or to the public within the next several years. They will consider companies that usually have the following features:
Swift and steady sales growth;
A sound management;
A new technology or a dominant position in the emerging market;
A potential for acquisition by a larger firm or going public in a stock offering.

Venture capital firms, in addition, define their investments through the company’s life cycle:
Seed financing;
Start-up financing;
Second stage financing;
Bridge financing;
And leveraged buyout.

Some of them prefer to invest in businesses only during the start-up stage, where there is potential for return, but risk is highest. Others, however, only deal with second stage funding for a business expansion. They can also choose to engage in bridge financing and provide capital for the company’s growth, until it goes public. Lastly, there are venture capitalists that focus only on providing funds for buyouts led by the management.

There are many types of venture capital: investment banking firms, industrial venture capital pools, and private venture capital partnerships.

Industrial venture capital pools often concentrate on backing businesses with a high probability of success like tech firms or companies that uniquely use state-of-the-art technology. Investment banking companies, meanwhile, offer expansion funding by selling the business’ stock to the private and public equity investors. Some provide risk capital for early-stage and expansion financing.

Private venture capital partnerships provide the biggest risk capital financing for companies that are capable of generating a 30 percent annual return-on-investment. These firms join in the management and planning of the companies they support. They also have large capital bases to invest at all business stages, even reaching up to $500 million.

Raising money through investors can be a long, tedious process. Entrepreneurs should treat the situation like courtship or dating, where they can lose their chances in a snap. Promising companies targetting venture capitalists can start by coming up with a solid pitch and have all the necessary materials at their fingertips. Networking is also critical as venture capitalists use it to source deals and vet ideas. It is important to have someone credible – an attorney, another business owner, or a banker – to make the introduction for you. Lastly, treat them with integrity and respect to let them know your value as a business partner.