Venture Capital

Venture Capital Investments

Venture capital is capital provided by outside investors for financing of new, growing or struggling businesses. Venture capital investments generally are high risk investments but offer the potential for above average returns. A venture capitalist (VC) is a person who makes such investments. A venture capital fund is a pooled investment vehicle (often a partnership) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans.
Investments by a venture capital fund can take the form of either preferred stock equity or a combination of equity and debt obligation, often with convertible debt instruments that become equity if a certain level of risk is exceeded. The common stock is often reserved by covenant for a future buyout, as VC investment criteria usually include a planned exit event (an IPO or acquisition), normally within three to seven years.
In most cases, one or more general partners of the investing fund joins the Board of Directors of the new venture, and will often help to recruit personnel to key management positions.
Venture capital is not suitable for many entrepreneurs. Venture capitalists are very selective in deciding what to invest in; as a rule of thumb, a fund invests only in about one in four hundred opportunities presented to it. They are most interested in ventures with high growth potential, as only such opportunities are likely capable of providing the financial returns and successful exit event within the required timeframe that venture capitalists expect. Because of such expectations, most venture funding goes into companies in the fast-growing technology and life sciences or biotechnology fields. Because of these strict requirements, many entrepreneurs seek initial funding from angel investors.
Venture capitalists hope to be able to sell their stock, warrants, options, convertibles, or other forms of equity in three to seven years, at or after an exit event; this is referred to as harvesting. Venture capitalists know that not all their investments will pay off. The failure rate of investments can be high; anywhere from 20% to 90% of the enterprises funded fail to return the invested capital. In case a venture fails, then the entire funding by the venture capitalist is written off.
Many venture capitalists try to mitigate the risk of failure through diversification. They invest in companies in different industries and different countries so that the risk across their portfolio is minimized. Others concentrate their investments in the industry that they are familiar with. In either case, they usually work on the assumption that for every ten investments they make, two will be failures, two will be successful, and six will be marginally successful. They expect that the two successes will pay for the time given to, and risk exposure of the other eight. In good times, the funds that do succeed may offer returns of 300 to 1000% to investors.