Venture capital (VC) is extensively used today to support discerning startups and other businesses that have the potential for substantial and rapid growth. Earlier, Anand Jayapalan had spoken about how VC firms typically raise funds from LPs or limited partners in order to invest in promising startups or larger venture funds. Larger venture funds usually have a clear target in mind in terms of the type of companies they want to invest in. Hence, instead of investing in just one startup, they invest in several companies.
When investing in a startup, VC funding is provided in exchange for equity in the company. This money is not expected to be paid back on a planned schedule in the conventional sense like a typical business loan. VCs would rather maintain a longer-term view. They invest in startups with the hope that they will be able to enjoy outsized returns should the company be acquired or go public down the line. Most VCs tend to take only a minority stake, of 50% or less, when investing in companies. These portfolio companies become a part of a portfolio of investments of the firm.
Venture capital investments are risky by nature. They take place before a company goes public. In the case of early-stage companies, these investments might be needed even before a company has an established track record. As a result, the possibility of a loss is factored into the business model of venture capital. The odds of hitting a “home run” and earning over 10X the venture capital investment may take years to realize. The VC model works on the calculation that a few successful companies can pay dividends that far offset the losses. Venture capital has emerged as a huge economic engine that helps in:
- Spurring innovation
- Generating job growth
- Creating new business models that can bring significant industry changes
Earlier, Anand Jayapalan had spoken about how the funding provided by venture capital help nascent businesses and industries to flourish. They help in bringing a variety of innovative ideas to life. Moreover, VCs may also help fill the void that capital markets and traditional bank debt leave due to the risk associated with unproven business models, lack of collateral and limited operating history. VC funding especially plays a key role as a company starts to commercialize its innovation.
Venture capital fundraising and investment have been steadily growing in popularity with time. A lot of this popularity can be attributed to recycled liquidity from a highly active exit market that is looking to reinvest. There are also several nontraditional investors entering or vastly expanding participation in the VC arena, including:
- Hedge funds
- Private Equity
- Corporate venture
- Sovereign funds
No matter whether a startup needs VC funding or not, it would largely rely on the nature of the business. Startups requiring heavy upfront investment, like manufacturing facilities or a large sales team, should especially consider seeking VC funding. Venture Capital funding is also advantageous for startups that may take years to realize commercialization and revenue.
