Looking to define venture capital financing? Venture capital is a specific type of financing you can obtain through investors. It's an institutional or private investment made in the early stages of starting a company.

What Is Venture Capital?

Venture capital is a type of investment made in small businesses that have big growth potential. Those who invest in these businesses are called venture capitalists. Business owners can obtain venture capital from a number of sources, including:

  • Investment banks
  • Financial institutions
  • Individual investors
  • Other types of partnerships

Venture capital investments are made when an investor purchases shares of a company and becomes a financial partner. This type of investment is also known as patient risk capital or risk capital because it has the potential to lose the investor money if the business fails to succeed. Venture capital investments also take long periods of time to pay off.

Most venture capital comes from high-net-worth individuals and institutional investors. The capital is often pooled into one investment by dedicated investment firms. Venture capital is a great option for business owners looking to fund their startups or other company with large up-front capital requirements.

One important thing to note about venture capital is that it doesn't always come in monetary form. Some investors offer their managerial or technical expertise instead of money.

New companies or business ventures with limited operating histories can benefit from venture capital because it's a reliable source of raising money, especially if business owners don't have access to bank loans, capital markets, or other investment sources.

Venture capital investments are known to have the following characteristics:

  • Lack of liquidity
  • High risk
  • Long-term horizon
  • Reserved for innovative projects
  • Capital gains
  • Equity participation
  • Investors can participate in managing the business

The methods of financing venture capital include:

During a venture capital deal, ownership portions of a company are sold off to the investors through limited partnerships established by venture capital firms. In some cases, these partnerships include a pool of multiple enterprises. The difference between venture capital and private equity deals, however, is that the former focuses on new companies looking to obtain substantial funding to get started. Private equity largely deals with established corporations looking for opportunities to transfer ownership stakes.

A good source to turn to for venture capital firms is the National Venture Capital Association (NVCA).

What Are Angel Investors?

For up-and-coming businesses and small businesses, venture capital is often obtained from individuals with high net worth. These individuals are known as angel investors.

Angel investors have amassed wealth from various sources and are a diverse group of individuals. In fact, many of them are entrepreneurs themselves or retired executives looking to invest the money they've earned from building their business empires.

Venture capital in general only plays a minor role in funding new businesses. Aside from high-net-worth individuals, investors are usually large institutions such as insurance companies, financial firms, pension funds, or university endowments. These institutions only allot a small portion of their funds into high-risk investments.

The Stages of Venture Capital Investing

Whether you're investing venture capital into a startup or you're an entrepreneur seeking investors, it's important to understand the steps associated with venture capital investing.

The first step in approaching a venture capital investor is to submit a business plan. The plan should include:

  • An executive summary
  • A description of the investment opportunity
  • A review of the existing and expected competition
  • Financial projections
  • Management details

The seed stage is the first step in venture capital financing. Investors offer modest amounts of their own capital to help finance a new product or service's early development. These early investments often finance market research, product development, developing a business plan, and building a management team.

The formative stage includes both the seed stage and early stage when the money supports initial costs and daily operations while a company gets off the ground.

After the formative stage, venture capital financing goes toward an initial public offering. At this later stage, the service or product is already in production and is being sold on the market.

Finally, the balanced stage includes all of the previous stages and is when the company has gotten off the ground and is running at full operations.

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