Venture capital is one of the more popular forms of equityfinancing used to finance high-risk, high-return businesses. Theamount of equity a venture capitalist holds is a factor of thecompany’s stage of development when the investment occurs, theperceived risk, the amount invested, and the relationship betweenthe entrepreneur and the venture capitalist.
Venture capitalists usually invest in businesses of every kind.Many individual venture capitalists, also known as angels, preferto invest in industries that are familiar to them. The reason isthat, while angels don’t actively participate in the dailymanagement of the company, they do want to have a say in strategicplanning in order to reduce risks and maximize profits.
On the other hand, private venture capital partnerships andindustrial venture capitalists like to invest primarily intechnology-related industries, especially applications of existingtechnology such as computer-related communications, electronics,genetic engineering, and medical or health-related fields. Thereare also a number of investments in service and distributionbusinesses, and even a few in consumer-related companies, thatattract venture capitalists.
In addition to the type of business they invest in, venturecapitalists often define their investments by the business’ lifecycle: seed financing, startup financing, second-stage financing,bridge financing, and leveraged buyout. Some venture capitalistsprefer to invest in firms only during startup, where the risk ishighest but so is the potential for return. Other venture capitalfirms deal only with second-stage financing for expansion purposesor bridge financing where they supply capital for growth until thecompany goes public. Finally, there are venture capital companiesthat concentrate solely on supplying funds for management-ledbuyouts.
Generally, venture capitalists like to finance firms during theearly and second stages, when growth is rapid, and cash out of theventure once it’s established. At that time, the business ownereither takes the company public, repurchases the investor’s stock,merges with another firm, or in some circumstances, liquidates thebusiness.
There are several types of venture capital:
Private venture capital partnerships are perhaps thelargest source of risk capital. They generally look for businessesthat have the capability to generate a 30-percent return oninvestment each year. They like to actively participate in theplanning and management of the businesses they finance and havevery large capital bases–up to $500 million–to invest at allstages.
Industrial venture capital pools usually focus on fundingfirms that have a high likelihood of success, such as high-techfirms or companies using state-of-the-art technology in a uniquemanner.
Investment banking firms traditionally provide expansioncapital by selling a company’s stock to public and private equityinvestors. Some also have formed their own venture capitaldivisions to provide risk capital for expansion and early-stagefinancing.
Individual private investors, also known as angels, canbe friends and family who have only a few thousand dollars toinvest, or well-heeled people who’ve built successful businesses ina similar industry and want to invest their money as well as theirexperience in a business. Sponsored by the SBA’s Office ofAdvocacy, the Angel Capital Network (ACE-Net) is a nationwide,internet-based listing service that allows angel investors to getinformation on small, growing businesses looking for $250,000 to $5million in equity financing.
Small Business Investment Corporations (SBICs) arelicensed and regulated by the SBA. SBICs are private investors thatreceive three to four dollars in SBA-guaranteed loans for everydollar they invest. Under the law, SBICs must invest exclusively insmall firms with a net worth less than $18 million and averageafter-tax earnings (over the past two years) of less than $6million. They’re also restricted in the amount of private equitycapital for each funding. Being licensed and regulated by agovernment agency distinguishes SBICs from other private venturecapital firms, but other than that, they’re not significantlydifferent from those firms. For a complete listing of active SBICs,contact the National Association of Small Business InvestmentCompanies.
Specialized Small Business Investment Companies (SSBICs)are also privately capitalized investment agencies licensed andregulated by the SBA. They are designed to aid women- andminority-owned firms, as well as businesses in socially oreconomically disadvantaged areas, by providing equity funds fromprivate and public capital. As with SBICs, SSBICs are restricted inthe amount of their private funding. For information and adirectory of active SSBICs, contact the National Association ofInvestment Companies.
Before approaching any investor or venture capital firm, do yourhomework and find out if your interests match their investmentpreferences. The best way to contact venture capitalists is throughan introduction from another business owner, banker, attorney orother professional who knows you and the venture capitalist wellenough to approach them with the proposition.
