Venture capital is one of the more popular forms of equity financing used to finance high-risk, high-return businesses. The amount of equity a venture capitalist holds is a factor of the company’s stage of development when the investment occurs, the perceived risk, the amount invested, and the relationship between the entrepreneur and the venture capitalist.
Venture capitalists usually invest in businesses of every kind. Many individual venture capitalists, also known as angels, prefer to invest in industries that are familiar to them. The reason is that, while angels don’t actively participate in the daily management of the company, they do want to have a say in strategic planning in order to reduce risks and maximise profits.
On the other hand, private venture capital partnerships and industrial venture capitalists like to invest primarily in technology-related industries, especially applications of existing technology such as computer-related communications, electronics, genetic engineering, and medical or health-related fields. There are also a number of investments in service and distribution businesses, and even a few in consumer-related companies that attract venture capitalists.
In addition to the type of business they invest in, venture capitalists often define their investments by the business’s life cycle: seed financing, start-up financing, second-stage financing, bridge financing and leveraged buyout. Some venture capitalists prefer to invest in firms only during start-up, where the risk is highest but so is the potential for return. Other venture capital firms deal only with second-stage financing for expansion purposes, or bridge financing, where they supply capital for growth until the company goes public. Finally, there are venture capital companies that concentrate solely on supplying funds for management-led buyouts.
Generally, venture capitalists like to finance firms during the early and second stages, when growth is rapid, and cash out of the venture once it’s established. At that time, the business owner can choose to take the company public, repurchase the investor’s stock, merge with another firm, or in some circumstances, liquidate the business.
There are several types of venture capital:
- Private venture capital partnerships are perhaps the largest source of risk capital. They generally look for businesses that have the capability to generate a 30 percent return on investment each year. They like to actively participate in the planning and management of the businesses they finance and have very large capital bases – millions of rands’ worth – to invest at all stages.
- Industrial venture capital pools usually focus on funding firms that have a high likelihood of success, such as high-tech firms or companies using state-of-the-art technology in a unique manner.
- Investment banking firms traditionally provide expansion capital by selling a company’s stock to public and private equity investors. Some have also formed their own venture capital divisions to provide risk capital for expansion and early-stage financing.
- Individual private investors, also known as angels, can be friends and family who have only a few thousand rands to invest, or well-heeled people who have built successful businesses in a similar industry and want to invest their money as well as their experience in a business.
- Before approaching any investor or venture capital firm, do your homework and find out if your interests match their investment preferences. The best way to contact venture capitalists is through an introduction from another business owner, banker, attorney or other professional who knows you and the venture capitalist well enough to approach them with the proposition.
