What is Venture Capital?

Venture capital is an investment in a promising start-up, a small-cap or a mid-cap company, which has the potential to grow, by high net-worth individuals, financial institutions, and investment banks. This investment comes in exchange for stakes in the company, has a high potential for profit, but also involves considerable risk.

Venture capital is mainly in the form of monetary investment, but can also be in the form of managerial or technical expertise. The venture capitalist – the individual or entity making the investment – invests in the company when they see that it has significant potential for growth.

The venture capitalists remain invested in the company till it grows in size and position, allowing the venture capitalists to sell off their stakes in the company and secure the profit. While the company has to give away a part of its stakes in exchange for the venture capital, the venture capital becomes crucial for its expansion of operations, research and development, and hiring new resources.

Types of Venture Capital

There are various types of venture capital, which can be described based on the requirements of the funding and the growth stages of the company.

• Pre-Seed Capital: At this stage, the start-up is yet to take a definite shape, and its founders are only equipped with a potential business idea and a workable plan that has the potential to turn into a viable business. If the venture capitalists find the idea workable and the business profitable in future, they invest with the pre-seed funding to establish the start-up. This risk is very high at this stage.

• Seed Capital: At this stage, the start-up is in its formative phase, usually when its first service or product is ready or about to be ready. The venture capitalists can see the potential of the start-up product or service at this stage. The seed capital can be used to market the product or the service, hire new resources, or increase production or manufacturing. This risk is very high at this stage.

• Early Stage Capital: This type of venture capital is offered to a company or a startup that is at its early stages of production or manufacturing, and its product or service has already gone to the market. This funding helps the company expand or ramp up production or services, expanding its working base, or hiring additional resources. This risk is high at this stage.

• Expansion Capital: At this stage, the startup already has an established product or a service in place, but there is a need to increase the output and increase the volume of business. The expansion capital is specifically to be utilised for expansion purposes, which can be in the form of setting up new infrastructure or hiring additional resources. This risk is comparatively low at this stage.

• Late Stage Capital: At this stage, the company has achieved success with its product or service and has crossed key milestones in its journey. However, it still has a scope to grow manifold, for which it requires additional capital to increase the product, hire additional resources, and build new infrastructure. This risk is comparatively least at this stage.

Advantages and Disadvantages of Venture Capital 

For a company that seeks venture capital, it avails a set of benefits that can assist it in achieving growth, but it also has to endure several disadvantages, about which the company has to be prepared.

Pros of Venture Capital

A start-up or a small-cap or a mid-cap company that seeks venture capital receives a crucial boost that it needs to scale up its productivity to increase and expand its business. The venture capitalists not only offer monetary investment but also their expertise and management skills that can significantly improve the functioning of the company.

Also, the company that receives the venture capital is not obligated to repay the investment amount in case of a failure to grow or expand, or bankruptcy, because the venture capitalists are the shareholders in profit as well as loss.

Venture capital also comes with important connections that can aid the company in its marketing efforts and also swiftly get through bottlenecks. It also gives credence to a company and makes it easier for the company to raise more investment from other venture capitalists.

Cons of Venture Capital

A major disadvantage in availing venture capital is that the founders have to let go of a part of the stakes in the company. The percentage of stakes conceded by the company’s owner(s) depends on the type of venture capital and the stage of the company.

A pre-seed or seed capital usually comes with a higher percentage of stakes, while a late-stage capital or expansion capital comes with a comparatively lower percentage of stakes. The venture capital also gives the investor a say in the company, which can lead to a conflict of interest with the owner(s).

Features of Venture Capital

Venture capital is mainly offered to start-ups or small-cap companies because they have a high growth potential compared to large-cap companies or even mid-cap companies. The risks involved with investing in start-ups and small-cap companies are, however, also significantly high, and the possibilities of failure are also significantly high. For this reason, some venture capitalists may prefer mid-cap companies because of their stable nature and scope for growth. Also, venture capital is not a short-term investment.

Conclusion 

Venture capital should not be considered as free money; rather, it is a crucial opportunity to make the company grow. The venture capitalists would decide whether to make the investment or not based on the company’s potential and the market demand for its product.

In exchange for the investment, the venture capitalists would demand a stake in the company, which they would eventually sell when the company grows in size and potential. Venture capital has its advantages and disadvantages, which the company owner(s) or start-up entrepreneurs should carefully consider and weigh.

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