A venture capitalist is a person who gives money to a company as an investment for equity in the company. This investment usually requires a high rate of return because it is considered high risk. According to experts such as Wes Edens Chairman and Founder at Fortress Investment Group, the risk is reduced when the investor has knowledge and business sense. The usual investment is between $500,000 and $5 million, and the venture capitalist can expect a return of 20 – 25 percent.
When to Invest?
Venture capitalists usually invest in a company that they think will be sold to the public or a larger firm within the next two or three years. The features a company must have to attract a venture capitalist are:
•Steady and rapid sales growth
•A sound management team
•New technology or a dominant position in an emerging market
•The potential for being taken public in a stock offering or of being acquired by a larger company
What is a Business Life Cycle?
There are several stages in the life of a business, and venture capitalists often see their investment in terms of one of these stages. Stage one is seed financing or startup financing. This is usually the first money an entrepreneur has and may come from his or her own finances or a friend or family member. After that, there is second stage financing, bridge financing and leverage buyout. Investors vary in the stages where they like to put their money. Some only invest in the startup phase where the risk and rewards are highest. Other investors like to put their money in the second phase or expansion and growth phase. Some investors only venture capital when companies are in negotiations for a management-led buyout.
Different Types of Venture Capital
Private venture capital partnerships provide the largest investment and are usually interested in companies that can provide a 30 percent return every year. The investors like to participate in the management and planning of the businesses they finance and usually have a capital base of up to $500 million.
Industrial venture capital pools usually fund companies that are very likely to succeed such as innovative companies that use state-of-the-art technology or IT companies.
Investment banking firms usually provide funds by selling stock in the company to public or private investors. They may also form their own venture capital division to fund high-risk companies that need phase II and expansion capital.
Loans and Venture Capital
Businesses are funded by both venture capital and loans. Loans need to be repaid with interest over a stipulated period of time. These loans may be backed by collateral or by the business owner’s personal guarantee.
With venture capital the business gives private shares in the company in exchange for the money. The investor actually becomes a part owner of the company. Venture capital is often used in high growth industries where the risk is high because these businesses usually don’t have assets to back a loan.
The best way for an entrepreneur to find a venture capitalist is to ask his or her banker or attorney. They can also ask another business owner or professional who may have contacts with venture capitalists. If they are willing to give the required equity to the investor, they may get the financing they need to be on their way to a successful business venture.