Venture Capital

Knowledge Center

Definition of Venture Capital? Meaning.

In Corporate Finance, Venture Capital is the private or institutional financial capital (money, investment) provided to relatively early-stage companies (ventures).

Venture Capitalists are outside investors financing new (start-up), growing or struggling companies (turnaround). Such investments generally are high risk, but offer the potential for above average returns when the company files their Initial Public Offering. VC's are often wealthy former (chief) executives at firms similar to those which the partnership funds or subsidiaries of banks and other institutions with large amounts of available venture capital.

Conditions of Venture Capital

Venture capital investments 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.

Suitability of Venture Capital. Candidates

Venture capital is especially suitable for high-tech entrepreneurs, as venture capitalists often keen on 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.

Sometimes VC's specialize in providing certain types of venture capital, including seed money (to establish a Start-up Company), first round financing, Venture Funding, second round financing, and mezzanine level financing (immediately preceding an IPO).

Differences Between Venture Capital Funds and Business Angels

In their study on Business Angels (BAs) in Germany, Kraemer and Schillo (2011) listed the main differences between BAs and Venture Capital funds (VCs). While these are not exclusive and may vary across funds and individuals, the main distinctions between the two include the following:

1. BACKGROUND: While BAs themselves usually have entrepreneurship experience, VCs represent former finance professionals, consultants and specialists from specific industries.
2. INVESTMENT APPROACH: BAs usually invest their own funds resulting in smaller contributions and transaction costs. VCs, in contrast, act as intermediaries investing amounts of other investors.
3. INVESTMENT TIMING: While BAs may invest in any stage of the development of start-ups, their focus is mainly on seed and early stage ventures. VCs would invest in seed stage companies only in exceptional cases focusing more on early and later stage start-ups.
4. INVESTMENT INSTRUMENTS: While BAs normally receive common shares as exchange to their contributions, VCs seek to obtain preferred shares.
5. DEAL FLOW: BAs obtain information about investment opportunities from networks and angel groups. VCs' deal flow is more formalized with official proposal submission process.
6. DUE DILIGENCE: BAs normally conduct due diligence on targets by themselves. VCs have teams of frequently outside experts (lawyers, accountants, etc.) perform standardized due diligences on target companies for them;
7. GEOGRAPHICAL REACH: Most of BAs investments are locally based; VC funds increasingly invest on an international scale.
8. INVOLVEMENT WITH THE BUSINESS: BAs approach is very much hands-on contributing with their knowledge and network. VCs usually participate in the boards of their investment companies and have a strategic role.
9. RETURNS: achieving returns may represent only one of numerous reasons why BAs invest in particular ventures. On the contrary, generating returns for VCs is their ultimate goal for investing and to enable them to raise further funds for next investments.

Negotiating with Venture Capitalists. Terms and Best Practices

Negotiating a VC-deal is complex and the stakes are high, given the inherent uncertainty, risks and rewards of investing in a new startup company. For both the entrepreneur and the VC. That's why it's very important to have a good basic understanding of negotiating. The VC industry has its own protocols and language, and its advisable to have professional legal assistance (a lawyer specialized in VC deals) to assist with the many provisions present in a VC contract, such as liquidation preference, anti-dilution protection, pay to play, drag along rights, vesting schedules, etc. In his article "How to negotiate with VCs" (HBR, May 2013) Deepak Malhotra recommends the following 4 best practices in dealing with VCs:

• Understand your Leverage. What alternative funding / VC options do you have? Make sure you negotiate enough / plenty of cash in early financing rounds and avoid a situation of running out of cash and still having to renegotiate a new round of funding. Negotiate certain terms for a second round of funding already during the first round.
• Maximize Trust. Transparency is often less costly then you fear and helps to build long-term trust. Always play it straight. Especially when the other party is vulnerable.
• Focus on Value. Don't focus only on the initial valuation, investment level end equity dilution. Consider all long-term success scenarios for the future of your firm and calculate what the various terms would yield in each case. Don't give away the control over the company too easily in return for a more favorable valuation.
• Strive for Understanding. The terms that a VC proposes reveal how she views the prospects of your firm as well as concerns.

Source: Kraemer, H. and Schillo, M. (2011). Business Angels in Germany: EIFs Initiative to Support the Non-institutional Financing Market. EIF Research & Market Analysis. Luxembourg: European Investment Fund.

Forum New Topic Forum about Venture Capital. Acquiring Venture Capital: Financing Preferences of Startups Small firms, especially startups, face significant difficulties acquiring external funds due to various reasons. Unlike (...) 9   2 comments Quotes on Venture Capital. Quotations Hi, do you know of a remarkable, humorous quote by a famous person or a proverb related to venture capital? Thanks (...) 5   2 comments Bootstrapping Methods: Non-external Financing Strategies Applied by Start-ups In the light of vast difficulties that start-ups face while acquiring external funds, new ventures can increase their ch (...) 3   Misconceptions of Entrepreneurs About Venture Capitalists An interesting article for both entrepreneurs, venture capitalists (VCs) and Corporate Finance specialists is "6 Myths a (...) 2   3 comments 🔥 NEW Crowdfunding in an African Context What are key success factors of platforms mobilizing participatory funding or crowdfunding in an African context? (...) 1   Crowd Funding Tips and Advice Unless you are developing a simple app with a maximum development cost in the $10,000 range, or have a relatively simple (...) 1   Overview of Venture Capitalists Great information here. Is there a source of information or web site that identifies VCs and the particular areas that t (...) 0   Start a new forum topic about Venture Capital Share your opinion, knowledge and experience or ask a question (sign up for free first)

Best Practices Sign up The top-rated topics about Venture Capital. Here you will find the most valuable ideas and practical suggestions. Customer-funded Business Models In his research, Professor J. Mullins (2014) argues that customer-financed business models provide an alternative source (...) 21   6 comments

Expert Tips Sign up Advanced insights about Venture Capital. Here you will find professional advices by experts. How to Deliver a Business Pitch? Storytelling, Corporate Pitch, Pitching an Idea, Entrepreneurship, Assessing Pitches, Showrunners, Artists, Neophytes How do you deliver a very good pitch for some business idea or venture you want to sell? Kimberly D. Elsbach, who has a (...)

Information Sources Sign up Various sources of information regarding Venture Capital. Here you will find powerpoints, videos, news, etc. to use in your own lectures and workshops. Sources and Methods of Financing a Start-up Company or Small Business Finance, Start-up Financing, Small Business, SME, Bootstrapping, Equity Capital, Debt Capital, Venture Capital This presentation elaborates on the methods to finance a start-up company. The presentation includes the following secti (...) Introduction into Venture Capital Venture Capital, Investing This presentation provides an introduction into Venture Capital, and includes the following sections: 1. Outline 2. Wh (...) Business Valuation | Company Valuation | Firm Valuation Business Analysis, Company Analysis | Firm Analysis This presentation elaborates on the valuation and analysis of companies and include the following sections: 1. Company (...) What is Crowdfunding? 2-Minute Introduction Venture Capital, Crowdfunding, Business Loan, Business Financing, Startup Investing Entrepreneurs, startups or small business men need money to fund and build new ideas. The traditional and most common me (...) Preparing a Feasibility Study Feasibility Analysis This presentation gives an introduction into the concept of idea/business feasibility studies. The presentation consists (...)

Research Links Sign up Automatically jump to further useful sources regarding Venture Capital. News Videos Presentations Books More

Compare with: Initial Public Offering  |  Venture Funding  |  Exit Strategy  |  Vulture Capitalist  |  Turnaround Management

Return to Management Hub: Finance & Investing

More on Management  |  Return to Management Dictionary

This ends our Venture Capitalists summary and forum.