What Is Venture Capital?
Venture Capital (VC) is a form of private equity that focuses on startup companies. Its purpose is to help them grow and develop until they are big enough to attract institutional investors. VC firms usually invest in companies in the early stages of their growth. These companies are considered seed stage companies. The earliest round of funding is called Series A funding, and later rounds are known as Series B funding. VC firms are less active in late stage funding, which is typically done by hedge funds and private equity firms.
Entrepreneurs turn to venture capitalists for funding to create a business that offers an upside over traditional financing. While traditional forms of financing are available, these are not ideal for start-ups. They must repay the loan plus interest, and the pay structure of a bank can limit their upside in the company. Because of this, entrepreneurs often turn to venture capital as a solution to this problem. However, despite the low risk, it is not a good option for everyone.
In the United States, most entrepreneurs come from universities or corporations. Almost all basic research money comes from government or corporate sources. These institutions are better at finding and converting new ideas into successful businesses. But the downside of venture capital is that it doesn’t have pay structures that cap the upside of its investors. While this may not be ideal for everyone, it is beneficial for start-ups that have a good idea. VCs are willing to offer a higher risk than traditional lenders.
The process of VC investing is very straightforward. An entrepreneur pitches his or her idea to a venture capitalist, and the VC buys shares in the company. The VC then sells the product to the investor in exchange for equity. The investment is then sold to the investor. If it is a success, the VC sells it to the company in exchange for the equity they own in the company. If a VC believes in it, they are willing to give it to the business.
VCs typically seek market-beating returns. The average VC invests in startups that produce market-beating returns. The average LP expects a return of 500-800 basis points. The S&P 500 has an average return of 7% per year. With venture capital, the LPs will expect to earn at least 12%. The LPs will have a stake in the company and will often invest more than the founder.
The fund manager’s salary is based on the amount of money that he or she invests. The funds are organized into different stages of a business. An early stage fund will be a small company that has been operating for a few years. A late stage fund will have a large number of investors. A late stage fund will have a very high valuation and the GP will have no equity in the company. A later stage fund will be a company that has already made a profit.
