What Is a Venture Capitalist?
Is There a Venture Capitalist in Your Business's Future?
A venture capitalist is a person who invests in a business venture, providing capital for start-up or expansion. However, individual venture capitalists are a rarity; the majority of venture capital (VC) comes from professionally-managed public or private firms. Their business is to pool investment funds (from pension funds, large corporations, university endowment funds etc.) and find and invest in businesses that are going to provide their investors high rates of return.
Because these venture capital firms want higher return rates than other investments such as the stock market provide, they typically invest in promising startup or young businesses that have a high potential for growth but are also high risk. Venture capital firms typically invest in business sectors such as IT, bio-pharmaceuticals, clean technologies, semiconductors, etc.
Why Businesses Look for Venture Capitalists
An investment from a venture capitalist is a form of equity financing - the VC investor supplies funding in exchange for taking an equity position in the company. Equity financing is normally used by non-established businesses that are unable to secure business loans from financial institutions (debt financing) due to insufficient cash flow, lack of collateral, or a high risk profile.
A company may also solicit the participation of venture capitalists due to the need for additional business expertise.
For example, in 1981 Bill Gates decided that Microsoft needed strategic thinking and sound advice from an experienced business person and he was able to convince venture capitalist Dave Marquardt to invest in Microsoft and join the board of directors, even though Microsoft was not in need of investment capital at the time.
As it turned out, Dave Marquardt was the only venture capitalist ever to invest in Microsoft and he remained on Microsoft's board for over 30 years.
How Venture Capitalist Firms Work
Venture capitalist investments in businesses are typically long-term (the average is from five to eight years). This is normally how long it takes for a young business to mature to the point where its equity shares have value and the company goes public or is bought out. VC firms expect returns on investment of 25% or greater given the risk profile of the companies they invest in.
Venture capital firms obtain investment capital by pooling money from pension funds, insurance companies, and wealthy investors. The firm makes the decisions about which businesses to invest in and receives management fees and a percentage of the profits as compensation.
VC firms range in size from small (capital pools of a few million dollars, typically investing in only a few new businesses each year) to huge (billions of dollars in assets and invested in hundreds of companies). For example, Accel Partners, a VC investor in Facebook, Etsy, and Dropbox, manages over $6 billion in pooled funds.
Who Has Control of the Company When a VC Investor Is Involved?
Venture capitalist financing is a poor choice for entrepreneurs who wish to retain control of their business.
In exchange for providing funding most VC firms obtain majority voting rights by having the majority of the shares (or a preferred class of shares that are senior to common shares), as well as special veto rights. And venture capitalist investments are often structured so that in the case of a share sale the VC investors have priority rights in terms of compensation.
To additionally safeguard their investments, VC firms take an active role in the businesses they invest in, typically supplying a board member and involving themselves in all important management decisions, including exercising veto rights over issues such as the sale of the company, additional financing, major business expenditures, etc.
How Hard Is It to Get Venture Capital Funding for a Business?
The vast majority of businesses do not qualify for venture capital funding.
VC firms are very choosy about the businesses they invest in - according to the U.S. Small Business Administration less than .1% of businesses are funded by venture capital. Of the few that are able to obtain VC funding, almost all are firms that are past the startup stage and can demonstrate a viable product or service. Venture capitalists are generally not interested in small retail businesses; they're looking for businesses that they can ultimately take public and get big returns from. The vast majority of new business seed money still comes from the business owner themselves (see 8 Sources of Business Start Up Money) or from angel investors.
Famous Venture Capital-Backed Businesses*
*from National Venture Capital Association Statistics
Because of an investment by a venture capitalist, Bernard and Alex were able to move their company into the export market successfully.