Definition
Venture capital is a type of private equity, a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth. Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake, in the companies they invest in. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful. The start-ups are usually based on an innovative technology or business model and they are usually from the high technology industries, such as information technology, clean technology or biotechnology.
Venture Capital
Venture capital is financial support provided by moneyed investors to small business that requires initial help when they are starting up.
Provision of Venture Capital
Venture capital is typically provided to those new businesses that have solid ideas and plans as well as high potential for long term growth. By large, Venture Capital is one of the most important sources of funds for fresh startups since they do not have the financial assets to be able to approach the capital markets.
While the risk for the investor is certainly higher, such risks are offset by the higher-than average returns they might be able to accrue. This holds true especially if it’s a revolutionary idea that has not been implemented before.
Advantages
For such firms, if the idea ‘clicks’, then being the market pioneers, they would be able to create their own value and charge as per their own demands. Even when newer entrants muscle into their field, they would still be able to keep a dominant position by virtue of their pioneering status and in this way the Venture Capital financer’s investment would be assured. Conversely, if the idea was to flop and the firm may become insolvent the financer would lose his investment.
Disadvantages
However from the startup’s point of view, since the firm is heavily beholden to its financer, it has no choice but to give him a say in all decision making activities. And this opportunity is usually availed by the financer who would try his level best to minimize the risk of losing his investment.
Potentially it could make or break the startup, since without full control of its idea and revenue generation capabilities it would be forced to listen to the ‘advice’ of the financer and might not be able to implement ideas as fast and as aggressively as it may want to do so.
Other more fell funded players may step into the field and the ‘pioneering edge’ would be lost for the startup. In the long run this would have negative consequences for both the business as well as the financer who, even if he does not lose his investment would not be able to reap the windfall that he had envisaged.
Further Reading
- The structure and governance of venture-capital organizations – www.sciencedirect.com [PDF]
- A control theory of venture capital finance – heinonline.org [PDF]
- Venture capital and the finance of innovation – papers.ssrn.com [PDF]
- The role of venture capital in the creation of public companies: Evidence from the going-public process – www.sciencedirect.com [PDF]
- Strategic venture capital investing by corporations: A framework for structuring and valuing corporate venture capital programs. – elibrary.ru [PDF]
- The interaction between product market and financing strategy: The role of venture capital – academic.oup.com [PDF]
- Venture capital financing, moral hazard, and learning – www.sciencedirect.com [PDF]
- Financial contract design in the world of venture capital – www.jstor.org [PDF]
- Convertible securities and optimal exit decisions in venture capital finance – www.sciencedirect.com [PDF]
- Venture capital in Europe and the financing of innovative companies – academic.oup.com [PDF]
