Venture capital is a type of private equity financing, which is offered by venture capital funds or private capital firms to emerging businesses, mid-stage, and early-stage companies that are considered to have potential for growth or that have proven high growth potential. Venture capital funds are generally regarded as the major means through which private firms raise capital for early-stage businesses. However, there are other sources of venture capital raising such as the sale of equity by existing companies to related parties. There are also several options such as the use of debt and the issue of promissory notes. Venture capital funds also make leveraged investments, which in turn can be leveraged by other companies. In general, a venture capital firm focuses on two main areas of venture capital funding.
The first area in which venture capital firms look to raise funds is through the purchase of preferred stocks from existing investors. This is referred to as a secondary market investment. Venture capitalists may also choose to invest money in technologies or utilities that are not yet licensed for public distribution. A primary market in which venture capitalists actively invest is in the manufacturing, selling, and brokerage industries.
Another area in which venture capitalists actively participate in financing activities is through the use of debt. Debt is offered by either the venture capitalists themselves or by other investors. Venture capitalists typically prefer to issue debt by other private investors because of the significant tax benefits that become available to them under the present day federal income tax laws. Venture capitalists also prefer to issue debt to start up companies rather than directly to consumers.
Angel Investors: A venture capital firm will seek to obtain a loan or investment from an individual, group, or agency that is not a company but has the ability to provide startup capital. The term “angel investor” is somewhat confusing given that there are no formal regulations that specify the qualifications of an individual or entity providing funding. In most cases, an angel investor is someone who has first-hand experience with the products or services that the venture capital firm is seeking to fund. An angel investor typically will have signed a non-recourse agreement, which ensures that if the venture capitalist is unable to repay the loan, he does not suffer a loss.
Private Equity and Venture Capital: Venture capital funds are usually provided through investment banks such as JP Morgan Chase, Goldman Sachs, and Salomon Smith Barney; and venture capitalists through private equity firms such as Lehman Brothers, Bain Capital, andvese Capital. Private equity firms can be financed in one of two ways: through a process known as “private placement” in which the venture capitalist receives shares of the company for the total cost of the investment; or through a process called “round table” in which the partners within a venture pool invest together, rather than as an individual borrower. In both cases, the venture capitalist or partner generally retains a substantial portion of the company’s stock ownership. Venture capitalists are usually very wealthy individuals, who typically have interests and investments in many different businesses. Because these types of financing levels are not subjected to statutory reporting requirements, the majority of private investors will remain anonymous.
There are various advantages and disadvantages to both private equity and venture capital. While the rates of return for these forms of financing are typically much higher than for the more traditional loans from commercial banks and credit unions, the downside to private equity and venture capital financing is that the final cost may often be much higher due to the longer time required to properly evaluate a business’ potential for growth and success. Venture capitalists usually fund early-stage companies with the expectation of handsome returns. Because these companies are often backed by successful entrepreneurs, the final costs of these types of funding arrangements can often be crippling for the companies that require them. One of the goals of angel investors is to provide small business with the resources they need to achieve success, so the risks of investing in ventures that may not provide a long-term return are potentially high. However, venture capitalists are able to obtain a financial commitment from a company in only a handful of weeks, so the risk is relatively low.
