Venture capitalists (VCs) represent the most glamorous andappealing form of financing to many entrepreneurs. They’re knownfor backing high-growth companies in the early stages, and many ofthe best-known entrepreneurial success stories owe their growth tofinancing from venture capitalists.
VCs can provide large sums of money, advice and prestige bytheir mere presence. Just the fact that you’ve obtained venturecapital backing means your business has, in venture capitalists’eyes, at least, considerable potential for rapid and profitablegrowth.
VCs make loans to–and equity investments in–young companies.The loans are often expensive, carrying rates of up to 20 percent.Many venture capitalists seek very high rates; a 30 percent to 50percent annual rate of return. Unlike banks and other lenders,venture capitalists frequently take equity positions as well. Thatmeans you don’t have to pay out hard-to-get cash in the form ofinterest and principal installments. Instead, you give a portion ofyour or other owners’ interest in the company in exchange for theVCs’ backing.
The catch is that often you have to give up a large portion ofyour company to get the money. In fact, VC financiers so frequentlywrest majority control from and then oust the foundingentrepreneurs that they are sometimes known as “vulturecapitalists.” But VCs come in all sizes and varieties, and they’renot all bad.
Venture capitalists typically invest in companies theyanticipate being sold either to the public or to larger firmswithin the next several years. Companies they will considerinvesting in usually have the following features:
- Rapid, steady sales growth
- A proprietary new technology or dominant position in anemerging market
- A sound management team
- The potential for being acquired by a larger company or takenpublic in a stock offering
In addition, venture capitalists often define their investmentsby the business’ life cycle: seed financing, start-up financing,second-stage financing, bridge financing, and leveraged buyout.Some venture capitalists prefer to invest in firms only duringstart-up, where the risk is highest but so is the potential forreturn. Other venture capital firms deal only with second-stagefinancing for expansion purposes or bridge financing where theysupply capital for growth until the company goes public. Finally,there are venture capital companies that concentrate solely onsupplying funds for management-led buyouts.
There are several types of venture capital:
Private venture capital partnerships are perhaps thelargest source of risk capital and 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, like high-tech firmsor 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.
The way to contact venture capitalists is through anintroduction from another business owner, banker, attorney, orother professional who knows you and the venture capitalist wellenough to approach them with the proposition.
