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Venture Capital Basics – Understanding Venture Capital

Venture capital is often referred to as private equity or capital funding. Venture capital is basically a type of private equity funding which is offered by venture capital firms or private funds to budding startups, new businesses, and established businesses that have been deemed to possess high potential for growth or that have proven very high profit potential. Private equity is one of the largest sources of venture capital available today. Private equity funds also provide seed financing and later stage venture capital.

Venture Capital

The major benefits of venture capital are its high potential return on investment (ROI), the ability to raise a large amount of capital, and no credit requirements. Venture capital markets are highly competitive with hundreds of companies looking for capital. Venture capital is the most expensive form of venture capital because it involves obtaining a loan backed by a private firm instead of a venture capital firm. These loans carry a high interest rate compared to other forms of small business financing, but they have a much longer repayment period.

The first venture capitalists were usually wealthy industrialists who supported specific research firms. Today, venture capitalists are usually finance angels, private wealthy individuals, or corporate executives. Venture capitalists typically seek to support only high risk, high reward, high growth companies. Some firms do not qualify for venture capital funding, such as certain consumer packaged goods firms, software firms, small home-based businesses, and online e-commerce companies.

Venture capitalists typically fund new businesses with seed investments consisting of a combination of cash and equity. In most cases, venture capitalists will offer small amounts of cash to finance a start up without issuing any equity. The companies that receive this initial investment of cash are termed “pre-cit” companies. As long as the company meets the definition of a pre-cit, there is typically no need to provide additional equity to these companies.

While venture capital does not require an immediate risk-return relationship, most angel investors and private equity investors require a performance evaluation of a company at least three years post-closure. This performance evaluation is typically based on the industry in which the company operates and the company’s industry outlook. To meet these requirements, most new businesses must be in operation for at least five years. Businesses cannot expect to receive a one time investment from an angel investor or private investor without providing a significant return on their investment. Most entrepreneurs focus on achieving an exit strategy by year end, which can take six months to one year, depending on the business plan.

Most venture capital firms require a significant upfront fee for processing a loan. This may include a down payment of twenty percent or more of the total loan amount. In exchange for this fee, the company has committed itself to paying interest on the capital for a minimum of one year. Most companies will repay their individual or venture capital lenders within one to two years after they acquire their financing. The startup costs that are associated with securing venture capital can vary significantly, but are generally much less than the fees typically associated with traditional bank loans.