Explain The Meaning Of The Term Venture Capital

1. a) Explain The Meaning Of The Term Venture Capital

Definition of 'Venture Capital'

Money provided by investors to startup firms and small businesses with perceived

long-term growth potential. This is a very important source of funding for startups

that do not have access to capital markets. It typically entails high risk for the

investor, but it has the potential for above-average returns, Yafeh (2001).

Venture capital can also include managerial and technical expertise. Most

venture capital comes from a group of wealthy investors, investment banks and

other financial institutions that pool such investments or partnerships. This form

makes money by owning equity in the companies it invests in, which usually have

a novel technology or business model in high technology industries, such as

biotechnology, IT, software, etc. The typical venture capital investment occurs

after the seed funding round as growth funding round (also referred to as Series A

round) in the interest of generating a return through an eventual realization event,

such as an IPO or trade sale of the company. Venture capital is a subset of private

equity. Therefore, all venture capital is private equity, but not all private equity is

venture capital Blass, et al (2001).

On the other hand, a venture capitalist is a person who invests in a business

venture, providing capital for start-up or expansion. Venture capitalists are

venture capitalists often found in anecdotal evidence is that they encourage the

development of the one or two very high growth firms in their portfolio, and care

little about the rest of their portfolio. Some argue that venture capitalists are quick

to shut down companies; others suggest that venture capital is patient money and

venture capitalists recognize the option value in their investments and exert effort

to ensure companies do not close down.

The reduced failure rate of venture capital-financed firms is interesting especially

when viewed in conjunction with the growth results discussed earlier. The higher

growth rates of venture capital firms are seemingly consistent with the notion that

venture capital firms are focused on going for the big potential growth firms.

who, while also looking for a suitable investment, is also looking for a personal

opportunity.

In other words, the venture capitalist may have no business experience applicable

to the industry your company is involved in, and is focused on the potential rate of

return your company can provide. An angel investor often has business

experience relevant to your company and is interested in adding value to your

company, as well as making a return on his or her investment.

as product innovation or research development that require potential investors.

other hand, are mostly opulent retired individuals who are willing to venture

capital in the early stages of a company or growing business, in exchange for

shares and bonds of the company. This allows them to stay abreast with the

development of the business sector even while enjoying their retirement, Da Rin,

(2001).

Venture capital is most important at this very point for the progress and survival

of innovative SMEs. Following the intervention of venture capital funds,

companies experience a swift restructuring process while making considerable

progress on the institutionalization process. With the improving institutional

image, the company has the chance to reflect that success on to its financial

services with competitive prices and eventually helps in a fast and stable growth.

easier manner which normally could not have been overcome on their own. This

provides a major contribution to our companies' fast development and provides an

opportunity to our companies' second and third generations to reach a healthy

structure.

An informal venture capitalist can have two functions for a company: Firstly the

informal provides the actual capital injection and secondly, he can offer either his

advice or his network. Although this may seem trivial at first sight, such expertise

an informal investor

scratch. In recent decades, venture capital has played an instrumental role in

creating high-tech, high-growth industries such as information technology,

biotechnology, semiconductors and online retailing. 2008 investment data

suggests that other critical industries such as clean technology and social media

will join that list.

According to Botazzi, (2001), through their firms, venture capitalists pool their

money with additional funds from institutional investors such as pension funds,

endowments and foundations. These investors become “limited partners” in the

firm’s funds, which are typically designated for investment in specific industries

(e.g. information technology, life sciences, clean technology). Venture funds have

hope that they will be acquired or go public at a premium to the total amount

extraordinary risk. Young companies have little or no collateral to secure bank

loans, no assets or track records to attract financing from private equity firms and

no opportunities for short term gain to interest hedge funds. Venture capitalists

step in and assume this risk by providing capital in exchange for an equity stake

in the company. The VC’s goal is to grow the company to a point where it can go

public or be acquired by a larger corporation – at which time the firm and its

limited partners may capture their return if the exit is worth more than the total

investment.

Typically, VCs take seats on the boards of their portfolio companies and

counsel and contacts for marketing and assisting in hiring management. In this

way, they remain partners with the entrepreneurs in growing the company to a

point where it can stand on its own. As part of this process, the venture capitalist

guides the company through multiple rounds of financing. At each point, the

company must meet certain milestones to receive fresh funds for continued

growth. If the company fails to meet these goals, or if the risk profile changes

significantly due to market conditions or regulatory policy, the VC’s

responsibility to their limited partners will require them to walk away.

These elements – the patience, the hands-on guidance, the willingness to take on

risk and fail – make venture capital unique as an asset class. In no other

those of other countries.

technical support like human resource management is managed through venture

capital.

Throughout its history, venture capital has developed numerous life-changing

innovations into entirely new industries in just this way. In the 1970s, VCs helped

found the biotechnology industry through their investments in pioneering

companies’ like Genentech and Amgen. A decade later, venture funding was

growing the software development and semiconductor industries into prime

poised to extend this legacy today.

capitalists. Many have argued that VC and investment banks fuelled a

disproportionate number of new firms in sectors with “hot” IPO opportunities, in

the hope of early cashing out. We examine new firm creation as a function of the

IPO activity in the sector. Interestingly, we find that while there are a larger

number of new firm creations in response to increased IPO activity, the

proportion of VC-financed firms in these sectors does not change significantly.

Thus, it is not just venture capitalists that follow the trend of what seems

attractive to the public markets, but entrepreneurs in general, both those getting

VC and those who do not, seem to respond to perceived windows of opportunities

in similar ways. One could view this as economy wide signals being interpreted in

much the same way by different constituents interested in start-ups, as opposed to

companies in Japan, and pension funds in the UK. Venture capital investment

patterns also differ across countries in terms of the stage, sector of financed

companies and geographical focus of investments. We find that these differences

in investment patterns are related to the variations in funding sources - for

example, bank and pension fund backed venture capital firms invest in later stage

activities than individual and corporate backed funds – and we examine various

Venture capital has different sources from which they start their business. For

referred to as “sweat equity.

According to Gilson (1998), the initial cash needed is likely to be provided by the

founders, but may be supplemented by money from friends and family members

who have a variety of reasons to want to be a part of what the founders are doing.

This type of funding is sometimes referred to as “seed capital.” The founders may

also seek bank financing, but if the bank is willing to extend credit it will

probably be based on their personal assets or borrowing capacity. Banks rarely

lend to companies that do not have a track record of revenues and profits.

According to Botazzi, (2001), venture capitalists generally expect to see that the

founders have put in a combination of sweat equity and personal cash, and they

prefer to see that they have raised some money from friends and family. After

exhausting these sources, entrepreneurs may think it is time to approach venture

capitals to raise the funds they need to grow their business. In fact, although

Venture capital investment patterns also differ across countries in terms of the

stage, sector of financed companies and geographical focus of investments. We

find that these differences in investment patterns are related to the variations in

funding sources - for example, bank and pension fund backed venture capital

firms invest in later stage activities than individual and corporate backed funds

and we examine various theories concerning the relation between finance and

stage finance as other funds in these countries, whereas they tend to invest in

activities.

References

Allen, F. and D. Gale (1999), “Diversity of Opinion and Financing of New

Tubingen.

Black, S. and R. Gilson (1998), “Venture Capital and the Structure of Capital

Markets: Banks versus Stock Markets,” Journal of Financial Economies, Vol. 47, pp.

243-277.

BVK (2000), Venture Capital in Europa 1999 (German Venture Capital Association,

Berlin).

Blass, A. and Y. Yafeh (2001), “Vagabond Shoes Longing to Stray: Why Foreign

Firms List in the US,” Journal of Banking and Finance, Vol. 25, pp. 555-572.

Botazzi, L. and M. Da Rin, M. (2001), “Venture Capital in Europe: Euro.nm and the

Financing of European Innovative Firms,” forthcoming, Economic Policy.

Carlin, W. and C. Mayer (1999), “Finance, Investment and Growth,” CEPR