Venture Capital – Types, Features, Pros and Cons, Importance

The article talks about venture capital to help you understand if such type of funding is suitable for your startup or not.

Venture capital is one of the ways that startups obtain financing. For investors, on the other hand, it is a type of asset with which they can obtain significant returns. There are advantages and disadvantages of venture capital that we should know whether or not you are an investor or an entrepreneur. In this article, we will cover all about venture capital.

Content

• What is Venture Capital?
• Types of Venture Capital
• Types of Venture Capital Operations
• Characteristics of Venture Capital
• Advantages of Venture Capital Funds
• Disadvantages of Venture Capital Funds
• How Do Venture Capital Funds Influence Today’s Economy?

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What is Venture Capital?

Venture capital is a way for investors to help finance startup companies. It can be defined as – 

“Long-term minority and temporary investment, by specialized capital investment companies, in small and medium-sized companies with great prospects for profitability and/or growth.”

It is a type of financing granted to private businesses by investors in exchange for a partial portion of the company. 

As its name indicates, it is an operation that can involve risks. However, investors usually make this decision with certain guarantees. By acquiring a company asset, they become part of the management group or board, so they can help it to lead them to success. The main attraction for the investing company is the large profit margin that it can achieve once the company in which they invest grows.

Typically, these investments fall on companies linked to high-growth industries that use innovative technologies and can drive economic growth and productivity. 

Venture capital is an alternative to conventional financing. It allows emerging growth companies to obtain resources to start a business, strengthen their product portfolio, increase their capacities, improve their skills, have commercial scalability, and access to national and international markets.

Examples – Apple, Microsoft, and Google are some of the biggest brands to have received venture capital during their startup periods.

Types of Venture Capital

The term venture capital or private equity is often used interchangeably to refer to any investment not traded on a regulated market. However, there are more exact terms to define these investments according to the development phase of the company to which they are addressed:

Seed Capital 

Seed capital is required before a business’s launch to conduct market research and start forming a company. Investors acquire a part of the capital of companies in their early stages.

Growth Capital 

This type of private equity investment focuses on acquiring minority stakes in mature companies seeking financing for their expansion or restructuring plans.

Startup & Early-Stage Capital

This type of capital is used to recruit key management, conduct additional research, and prepare a product or service for the market. After launch, early-stage capital can help the business increase sales to reach the break-even point and increase efficiency. 

Expansion and Late-Stage Capital

Such funding expands a company’s production to other products or sectors and also increases market efforts for new products. 

Bridge Financing

Bridge financing is capital that can be offered to help a company reach an important milestone, such as an initial public offering or a merger.

Types of Venture Capital Operations

Based on the operation, venture capital funding can be categorized into three –

Management Buy Out (MBO)

MBO is a venture capital investment under which an already mature company is acquired. It consists of the purchase operation of a company, part of it, or its assets by some executives who work in it by a venture capital company.

Management Buy-In (MBI)

This is the acquisition of a company by external managers supported by a venture capital firm.

Buy-In Management Buyout (BIMBO)

BIMBO is about the purchase of a company in which control is assumed by a team of managers who work in the company, acquired together with the support and backing of external managers.

Characteristics of Venture Capital

Venture capital is a source of business financing mainly aimed at small and medium-sized companies. The investment is made by a specialized investment company that takes a minority position in the receiving company in the medium to long term.

Listed are the main characteristics of venture capital –

• Venture capitalists take a share in the company’s capital stock by purchasing shares.
• It is a way of channeling savings, making up for the need for more self-financing of SMEs.
• The receiving company is limited to letting the investment company enter its shareholding. However, it is normal for the receiving company to bear the costs caused by the investment company’s entry into that capital.
• Venture capitalists invest in small and medium-sized companies because they can offer the greatest possibilities for expansion and development.
• Investment is usually directed to new economies.
• The investment is mainly for companies in the growth or start-up phase.
• The investment company assumes greater risks than those that a credit institution is normally willing to assume.
• For venture capital investors, the main benefit is obtaining high capital gains from the sale of the stake held by the investment company, known as the process of divestment or exit from the investee company.

Advantages of Venture Capital Funds

The main advantages of venture capital funds for entrepreneurs and startups are the following:

• Access to financing that, sometimes, cannot be obtained through traditional banking and financial entities.
• Eliminate the constant worry of facing a debt that you must pay regardless of the growth of your business.
• Promote the development of your project with one of the most comprehensive types of investment since it not only contributes with resources but also with relationships, experience, professionalism, and advice in the administration of your business.
• Earn a good reputation for your project and your brand with the participation of a venture capital company.
• Being at the forefront of technology, new business models, and learning. Many investors want to be in this sector to learn from diverse technologies or sectors.

Disadvantages of Venture Capital Funds

• Depending on the % that they take, whether private equity or venture capital, venture capitalists can control the company and ultimately decide what should be done.
• Venture capital funds often incorporate control clauses and vetoes that limit your independence as a company manager. 
• Certain decisions have to be communicated in an organization, and they need to take investors’ approval.
• Venture capitalists also usually put economic clauses stressing that they will be the first to obtain investment returns or ensure minimum profitability.
• The funds have a specific period, from 3 to 5 years, in which they need to generate a divestment. This implies the possibility of generating pressure on the management/founding team of the company to grow or to find ways out for the venture capital funds.

How Do Venture Capital Funds Influence Today’s Economy?

Venture capital funds are of great help in different commercial and economic contexts. Thanks to this kind of monetary fund, it is possible to channel investments into businesses with high potential. High profitability is observed if it is given the appropriate economic boost. In fact, by providing capital to these types of companies, the local economy is also boosted. Likewise, it is possible to promote innovation within different labor and economic sectors.

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