How Venture Capital Firms Work


Venture Capital is a form of high-risk funding option that organizations and companies take up with the expectation of whopping returns.

Entrepreneurs who are willing to expand their companies have to find such institutions or individuals who could give money to boost their businesses. It could be the case that you might have applied for bank financing, but the bank did not grant it. It could also be the case that the bank told you that your business is not a prudent investment or is a reasonable risk. In such cases, you shall have to find such institutions or individuals who could take on the supposed risky investment. This investment would be made based on your proving that ultimately, your business idea would be a success. Precisely, this risk investment is what a venture capitalist does.    

Venture capitalist individuals and firms work under specialized profiles of investments. The patterns of investment are the guidelines which denote the nature of business in which a venture capitalist firm invests. In effect, this means that a particular venture capitalist firm would target one specific type of business domain for investing. Such personal investment holding company are more prone to providing funding option to startups and entrepreneurs rather than established businesses. It is because the established companies can quickly obtain rather traditional funding options such as bank loans.

The Means And Ways Of A Venture Capital Firm

From the perspective of a company, the process operates in the following way. A startup comes to the foray, and now it needs money to move forward. So, it approaches a venture capitalist firm to pour money into it. The initiators of the startup make up a business plan demonstrating their vision of what they would become over a specific period. The project also highlights the revenue and profits they think they would be getting from the expanded startup in the time to come. Then the venture capital firms go through the plans and analyze the true potential of the startup. If the venture capital firm is satisfied with the growth potential of the startups, as was demonstrated by the business plan, they fund the startup.

Seed funding is the term used to denote the initial functioning of the startups. Subsequently, the startup receives more and more funding in the various rounds. After that, the startup expands and becomes a public company or gets acquired by another company. 

What A Venture Capital Firm Gets In Return

As compensation for the funding received by the startup, venture capital firms acquire some of the controls in the startup. The venture capital firm obtains some of the rights in the decision making of the startups. These rights in decision making are affirmed by having a seat of venture capital firm in the board of directors of the company. The venture capital firm might also put a pre-approval condition on expenditures above a certain amount. Not all but some venture capital firms may also acquire the right to grant approvals for hiring some of the organizational posts. In some of the cases, venture capital infusion might also bring domain expertise and contacts in the portfolio of the startups. 

Usually, venture capital firms anticipate the liquidation of all the investments made in three to seven years after the startups become publicly listed. 

Points of Negotiation

An essential factor that a startup must negotiate before venture capital infusion is the amount of stock to be given to the venture capitalist firm. For this, a valuation of the company is to be carried on. Both parties, venture capital firm, and the startup need to be on the same page regarding the worth of the startup beforehand. The worth estimation of any startup before the venture capitalization is the domain of pre-money-valuation. The best description of pre-money-valuation is the overall worth of the startup on its own, without any external capitalization. 

Pre-money valuation gives venture capitalist firms an idea of the existing worth of the company. Not just this, this estimate also determines each released share’s value.   

Wrapping Up

For new and startup companies, venture capital firms are excellent places. Such small companies are often unable to raise capital from public stock exchanges. Also, they could not even secure a loan from the bank. The key here is to locate a venture capitalist firm that has expertise in the domain you deal. If you could successfully hunt such a firm, you would be having the requisite capital for expansion of your startup.