For most entrepreneurs, “safety” and “certainty” are no longer part of their vocabulary. Entrepreneurs are visionaries and risk-takers who are willing to take a chance for the opportunity to achieve their dreams. The entrepreneurial spirit that makes individuals and companies go into business will only take them so far. Essential to the success of any business is the ability to raise money to grow. Venture capital companies provide new or established entrepreneurial companies with the financial safety net when conventional debt financing is not available.
Venture Capital Versus Debt Financing
Most startup companies or businesses in emerging markets do not have the collateral that banks and other conventional lending institutions require to secure the loan. Debt financing places a burden on the cash flow of a business by adding an additional monthly payment to a company’s bottom line. Many new companies quickly discover that some conventional lenders will not approve their applications because they are considered to be high-risk borrowers.
Venture capital companies generally do not require collateral. Venture capitalists are investors who provide money to entrepreneurial companies offering growth potential in exchange for an equity interest, usually in the form of shares in the company or a seat on the company’s board of directors and an active management role in the business. The high risk associated with venture capital is offset by the rate of return on investment that is higher than debt lenders receive.
Long-Term Role of Venture Capitalists
Investors that give money to companies in exchange for an equity interest in the business do so knowing that theirs is a long-term investment requiring them to be active in the operations of the company. Venture capital companies want to generate growth in the companies in which they are investing in order to maximize the rate of return on their investment. As equity owners, the investors benefit by helping management to generate higher profits than before.
Although capital investors are in it for the long term, the point of the investment is to maximize the rate of return while also having an exit strategy. Knowing when to dispose of the investment can be as important as picking the right company to invest in.
Making the Decision to Invest
Most venture capital firms require a business plan from a company asking for assistance. The business plan is usually reviewed to determine if it meets the investment goals of the venture capitalist. Some venture capital firms only invest in specific industries or in companies in geographic locations such as emerging global markets.
After reviewing the business plan, a venture capital investor will look at the management, products, history and financial statements of the target company. Once it is satisfied that the target company fulfills the criteria for investment established by the venture capital firm, an offer is made to the target company.
Source of Funds
Some venture capital companies invest their own money and retain the return on investment. Other companies have investors who rely on the venture capital company to find an appropriate company to invest in. The venture capital company shares in the profits along with the investors.