Venture capital

The essentials

Venture capital (VC) is long-term risk capital provided by professionally managed funds to new or growing businesses that have high growth potential but also high risk. Venture capital funds pool money from investors such as financial institutions, wealthy individuals and pension funds and invest it in selected ventures, usually in return for equity.

Key points

Features of venture capital:

• Equity participation: the investor usually takes shares or convertible instruments.
• Long-term investment: funds are typically locked in for several years.
• High risk, high return: invests in innovative or technology-based ventures with strong growth prospects.
• Participation in management: the venture capitalist often takes a board seat and gives strategic advice.
• Planned exit: the investor sells its stake once the venture has grown.

Stages of venture financing:

• Seed stage: money to test an idea or build a prototype.
• Start-up stage: money to begin operations and launch the product.
• Early (first) stage: funds when the business has begun selling but needs more capital.
• Expansion (second) stage: funds to grow capacity or enter new markets.
• Mezzanine or bridge stage: funds just before a public issue.

Exit routes: initial public offer, sale of the stake to another company (trade sale), or buy-back of shares by the promoters.

Venture capital process: deal origination, screening, evaluation (due diligence), deal negotiation, post-investment monitoring, and exit.

Exam tips

• Remember the order of financing stages and that bridge finance comes just before an IPO.
• Know at least three features and three exit routes.

Common mistakes

• Treating venture capital as a short-term bank loan.
• Thinking venture capitalists stay invested for ever; exit is planned from the start.