Venture Capital is a financial tool for companies and wealthy and institutional investors usually in exchange for equity shares in the company. It focuses on wealthy investors who invest in startups with long-term profit and growth perspectives. It is easy for small business owners to receive money in the short term and for investors to receive profit in the long term which is the whole purpose of venture capitalists. Venture capitalists tend to choose emerging companies which can be very risky as the investments are illiquid but also can provide magnificent returns if invested in the right venture.
They participate in the firm by equity and capital gains and also by lending conditional loans to the companies.
WORKING OF VENTURE CAPITAL
Venture capitalists have the power of decision making, monitoring the progress before releasing additional funds, and guiding the companies to profitable growth in the companies. In a startup, the most important role is where the raised fund is invested in the next stage for the transformation life cycle where the company starts to commercialize its innovation.
According to us, around 70-80% of the money invested by the VCs goes to expense investments like manufacturing, sales, marketing, branding, etc, the balance sheet, which is providing working capital and fixed assets, and the infrastructure which is required to grow the business in. Venture money is not a long-term investment, the investors exit the business after some years of their initial investment by the process of acquisition, merger, or IPO after it reaches sufficient credibility and size so that the institutional public equity markets can take over and provide liquidity.
ADVANTAGES OF VENTURE CAPITAL
Connections – The venture capitalists are well connected in the market and business community. Tapping into these connections could be of great benefit to startups and new businesses.
Finances – Large amounts of equity finance can be provided as new ventures are not obligated to repay the raised amount and thus give them space to accelerate their growth.
Business Expertise – Apart from the wealth venture capitalists provide they help the young startups with valuable sources of guidance and consultation. This also helps the VCs to make important decisions like financial management, marketing, etc, and have a say in the companies growth.
Additional Growth – In many of the critical areas like legal matters, tax, etc the venture capitalists provide active support which is a crucial part in the early stage from startups. Moreover, as the equities are uncovered there is no limit as to how much the investors can earn.
DISADVANTAGES OF VENTURE CAPITAL
Minority ownership position – Depending upon the investor’s stake in your company, which can be more than 50% could lead to losing the management control. Fundamentally, you will be giving control and ownership of your startup.
Loss of control – With the financing and professional and possibly aggressive investors, the VCs will have involvement in your company and decisions. The more their stakes the more decisions they will be involved in for shaping your company’s direction.
To conclude, the logic of the deal is to give the investors both favorable positions in the company so that they are secure about the funds they are providing and possible downside protection if the deal goes south. And as for the young entrepreneurs, the deciding factors should be;
- Could you gain from the connections of the VC’s firm businesses?
- Do you respect the additional resources and expertise will the investors will provide?
- Will the loss of control and ownership be an issue for you?
- If you lack skills to make your business grow like marketing, experience, finances, a VC might be of great benefit.