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| Venture Capital |
The term "venture capital" usually refers to funds that are raised and pooled together for the specific purpose of investing in start-up or early-stage business enterprises. "Venture capitalists" are the people who manage the funds. While venture capitalists oftentimes invest their own money in their ventures, most of them will seek out other investors to bring together as part of a limited partnership or some other form of a pooled investment fund.
The goal of venture capitalists is to invest in companies that will dramatically increase in value and allow the investors to cash in on big capital gains. It's a risky business, because many of these companies fail. In recognition of this risk, venture capitalists have traditionally insisted on having a significant ownership interest in and control over the companies they fund.
To increase their chances of investing in a profitable start-up, venture capitalists are continually adopting and implementing new strategies on their investments. Beyond simply contributing capital, for example, venture capitalists like to picture themselves as being strategic partners in the growth and development of the companies they fund. This may include:
- Participating on a company's board of directors
- Providing advice on key issues relating to the development of the company (for example, staffing, customers, suppliers and analysts
In short, they can make things happen, which can make them a great ally in making a new business successful. Trying to secure venture capital could be a great idea if you have a fledgling business with a lot of potential for expansion, or even a great business idea but no way to fund it.
But there is a big trade off you have to recognize up front: venture capital may allow someone to build a huge enterprise with the potential for untold personal wealth, but it may come at the price of losing control over a company you founded and sacrificing your personal lifestyle in the process.
What will venture capitalists look for in a company? They will want to see:
- A good idea for making money
- Founders who are willing to invest their own money in the venture
- A great business plan that reflects sound and realistic thinking,
- An established or promising product and market
- Some operating history that shows promise of success
Strong management is also important, although venture capitalists often expect to provide or bring in additional management expertise.
What will venture capitalists want in return for the big bucks and experience they provide?
- A large position in your company, which will dilute the founders' ownership
- Liquidation preferences where they may get their money back at least several times over before sharing profits with other shareholders
- Seats on the board of directors and special rights that allow them to oversee management
- They'll also want an "exit strategy" that will allow them to cash out of the company within a relatively short period of time (typically two to five years)
Usually, venture capitalists insist on "registration rights" - the right to make the company register their stock for sale to the public at some point in the future. They also receive "preferred" stock, which is entitled to be paid before common stock if the company liquidates.
Preferred stock is oftentimes issued in series, with the first round typically being called "Series A Preferred Stock." The next round would be the "Series B" round, and so on, often going up to a "Series D" or "Series E" round before the company has a public offering or realizes some other exit strategy that allows the venture capitalists to get their money back.
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