Venture Capital – Types, Features, Pros and Cons, Importance

Venture capital funds represent a good opportunity for investors willing to invest their money in long-term business projects. The main objective of venture capitalists is to carry out investments in companies temporarily, to support the development and growth of these companies and to obtain a final return with the divestment. The article talks about venture capital to help you understand if such type of funding suits your startup.

Venture capital is one of the ways that startups obtain financing. For investors, on the other hand, it is a type of asset with which they can obtain significant returns. There are advantages and disadvantages of venture capital, and we should know whether you are an investor or an entrepreneur. In this article, we will cover all about venture capital.

Courses ALERT: Explore FREE Online Courses by top online course providers like Coursera, edX, Udemy, NPTEL, etc., across various domains, like Technology, Data Science, Management, Finance, etc., and improve your hiring chances. 

Content

• What is Venture Capital?
• Types of Venture Capital
• Types of Venture Capital Operations
• Characteristics of Venture Capital
• Advantages of Venture Capital Funds
• Disadvantages of Venture Capital Funds
• How Do Venture Capital Funds Influence Today’s Economy?

Explore Investing Courses

What is Venture Capital?

Venture capital is a way for investors to help finance startup companies. It can be defined as – 

“Long-term minority and temporary investment, by specialized capital investment companies, in small and medium-sized companies with great prospects for profitability and/or growth.”

It is a type of financing granted to private businesses by investors in exchange for a partial portion of the company. 

As its name indicates, it is an operation that can involve risks. However, investors usually make this decision with certain guarantees. By acquiring a company asset, they become part of the management group or board, so they can help it to lead them to success. The main attraction for the investing company is the large profit margin that it can achieve once the company in which it invests grows.

Typically, these investments fall on companies linked to high-growth industries that use innovative technologies and can drive economic growth and productivity. 

Venture capital is an alternative to conventional financing. It allows emerging growth companies to obtain resources to start a business, strengthen their product portfolio, increase their capacities, improve their skills, have commercial scalability, and access to national and international markets.

Examples – Apple, Microsoft, and Google are some of the biggest brands to have received venture capital during their startup periods.

Types of Venture Capital

The term venture capital or private equity is often used interchangeably to refer to any investment not traded on a regulated market. However, there are more exact terms to define these investments according to the development phase of the company to which they are addressed:

Seed Capital 

Seed capital is required before a business’s launch to conduct market research and start forming a company. Investors acquire a part of the capital of companies in their early stages.

Growth Capital 

This type of private equity investment focuses on acquiring minority stakes in mature companies seeking financing for their expansion or restructuring plans.

Startup & Early-Stage Capital

This type of capital is used to recruit key management, conduct additional research, and prepare a product or service for the market. After launch, early-stage capital can help the business increase sales to reach the break-even point and increase efficiency. 

Expansion and Late-Stage Capital

Such funding expands a company’s production to other products or sectors and also increases market efforts for new products. 

Bridge Financing

Bridge financing is capital that can be offered to help a company reach an important milestone, such as an initial public offering or a merger.

Boost your financial knowledge and expertise with an online MBA in Finance. Master investment management, risk analysis, and financial planning and analysis from top institutions like IIMs, XLRI, MDI, and Amity Online. Also learn essential soft skills, such as problem-solving, decision-making, and business transformation.

Types of Venture Capital Operations

Based on the operation, venture capital funding can be categorized into three –

Management Buy Out (MBO)

MBO is a venture capital investment under which an already mature company is acquired. It consists of the purchase operation of a company, part of it, or its assets by some executives who work in it by a venture capital company.

Management Buy-In (MBI)

This is the acquisition of a company by external managers supported by a venture capital firm.

Buy-In Management Buyout (BIMBO)

BIMBO is about the purchase of a company in which control is assumed by a team of managers who work in the company, acquired together with the support and backing of external managers.

Characteristics of Venture Capital

Venture capital is a source of business financing mainly aimed at small and medium-sized companies. The investment is made by a specialized investment company that takes a minority position in the receiving company in the medium to long term.

Listed are the main characteristics of venture capital –

• Venture capitalists take a share in the company’s capital stock by purchasing shares.
• It is a way of channelling savings, making up for the need for more self-financing of SMEs.
• The receiving company is limited to letting the investment company enter its shareholding. However, it is normal for the receiving company to bear the costs caused by the investment company’s entry into that capital.
• Venture capitalists invest in small and medium-sized companies because they can offer the greatest possibilities for expansion and development.
• Investment is usually directed to new economies.
• The investment is mainly for companies in the growth or start-up phase.
• The investment company assumes greater risks than a credit institution usually is willing to assume.
• For venture capital investors, the main benefit is obtaining high capital gains from the sale of the stake held by the investment company, known as the process of divestment or exit from the investee company.

Advantages of Venture Capital Funds

The main advantages of venture capital funds for entrepreneurs and startups are the following:

• Access to financing that, sometimes, cannot be obtained through traditional banking and financial entities.
• Eliminate the constant worry of facing a debt that you must pay regardless of the growth of your business.
• Promote the development of your project with one of the most comprehensive types of investment since it not only contributes with resources but also with relationships, experience, professionalism, and advice in the administration of your business.
• Earn a good reputation for your project and your brand with the participation of a venture capital company.
• Being at the forefront of technology, new business models, and learning. Many investors want to be in this sector to learn from diverse technologies or sectors.

Disadvantages of Venture Capital Funds

• Depending on the % that they take, whether private equity or venture capital, venture capitalists can control the company and ultimately decide what should be done.
• Venture capital funds often incorporate control clauses and vetoes that limit your independence as a company manager. 
• Certain decisions have to be communicated in an organization, and they need to take investors’ approval.
• Venture capitalists also usually put economic clauses stressing that they will be the first to obtain investment returns or ensure minimum profitability.
• The funds have a specific period, from 3 to 5 years, in which they need to generate a divestment. This implies the possibility of generating pressure on the management/founding team of the company to grow or to find ways out for the venture capital funds.

What is Corporate Venture Capital?

Corporate Venture Capital, or CVC, refers to a corporation investing money into external startups. The primary aim is to test new ideas, drive innovation, and generate strategic benefits for the company that invests.
Startups often look for these big companies to try out their technology, create new partnerships, acquire customers, or raise capital. In return, CVC provides startups access to new markets by connecting them to the network of partners and clients of the corporation. Secondly, CVC offers excellent legal services, marketing, and facilities support, giving a complete package of resources suited to the startup's needs.

How Do Venture Capital Funds Influence Today’s Economy?

Venture capital funds are of great help in different commercial and economic contexts. Here are some of the ways venture capital will influence the economy -

1. Accelerating Start-Up Growth: Venture capital funds enable short-growth potential by offering financing necessary to develop high-growth-potential start-ups. Businesses can expand fast, scale up their operations, and gain higher returns on investments.

2. Stimulation of Regional Economies: Businesses begin creating new jobs and means of income generation within regional economies.

Regional economies benefit from increased production, wages, and consumer spending.

3. Encouraging Innovation: Venture capital fosters business innovation and experimentation through new ideas, products, and technologies.

Investment in innovation can lead to breakthroughs in various sectors, including technology, healthcare, and finance.

4. Futuristic Industries: Venture capital helps shape future industries by supporting high-potential companies and creating competitive markets.

New and disruptive technologies funded by venture capital can change existing sectors into more efficient and sustainable practices.

5. Increased Investments: The success of venture-backed companies often attracts more investors to the market,  creating a cycle of continued investment and economic growth.

Top Trending Finance Articles:

Financial Analyst Interview Questions | Accounting Interview Questions | IFRS Certification | CPA Exams | What is Inflation | What is NFT | Common Finance Terms | 50-30-20 Budget Rule | Concept of Compounding | Credit Cards Rewards System | Smart Budgeting Approaches