Venture capital is a high risk-high potential type of financing where the investor seeds a startup that could potentially earn great returns. This type of funding is common in the fields of IT, biotechnology and software development. In these types of fields, there is a high level of uncertainty whether the product in development will be viable and whether it will resonate with the customers as anticipated – hence the high risk factor. The investor gets a stake in the company’s equity in exchange for his funding.
Venture capital does not necessarily have to be in monetary terms, the investor can choose to invest his knowledge and expertise as capital for the start-up. Most venture capitalist are wealthy individuals, companies and banks. The advantage for venture capitalists is that they could potentially score big returns if the business becomes a success. The advantage of this type of funding is that the entrepreneurs are able to get funding for their project even if they don’t have a good credit rating. The downside however is that the entrepreneurs have to forego part of the ownership stake in their companies.
There are different financing stages in venture capital, these include: seed funding, growth financing, second round financing, expansion, and bridge financing, as well as exit of venture capitalist.
- In the seed funding, the investor merely finances an idea. The entrepreneur needs this money to gather market information and develop a working prototype, enter the second stage of financing where the investor finances the process of getting the product out to the market.
- Growth financing follows where the entrepreneur needs money for early sales and manufacturing. At this stage the product is in the market.
- What follows is the second round of financing where the business needs money injected because although they are making sales, they have still not turned a profit and they need money to cater to operational expenses and overheads.
- After the business turns a profit then the next viable thing is to expand it – this will need money which the investors need to cough up.
- When the business is up and running and profit then it may need to go public, this is the bridge financing and the final stage of venture capital.
Venture capital fosters entrepreneurship and in the process stimulates economic growth and development. It also makes innovation and inventions happen because it provides the support that entrepreneurs need to create a new and exciting product. The investors mitigate the risk involved in venture capital by diversifying their investment portfolio.