The Meaning of the Term Venture Capital
MSPM 6102 - Practices in Project Management
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 of raising capital is
popular among new companies or ventures with limited operating history, which cannot
raise funds by issuing debt. The downside for entrepreneurs is that venture capitalists
usually get a say in company decisions, in addition to a portion of the equity
Venture capital can be defined as a financial capital provided to early-stage, high-
potential, high risk, growth startup companies. The venture capital fund 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 looking for a higher
rate of return than would be given by more traditional investments.
ii) Discuss the Importance of Venture Capital as a Means of Funding new or
Rapidly Growing Small Business.
Perhaps surprisingly, we also find that venture capital financed firms are less likely to fail
than non- venture capital -financed firms. One characterization of 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. However, our survival
result suggests that venture capital-financed firms do better than the average non-venture
capital-financed firm not just in terms of having higher growth rates but also, in part,
from reduced failure rates.
A business person who engages in venture capital is known as a venture capitalist. A
venture capitalist is a professional investor. He or she manages a fund and is looking for
suitable investments for that fund. An angel investor is an individual 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.
The venture capitals are very important for entrepreneurs who have projects such as
product innovation or research development that require potential investors. Financial
institutions such as banks offer loans to the entrepreneurs, but they demand the payment
of interest on the invested capital. Angel investors, on the 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 figures. While the financial structure of
the company improves its market image with other companies, goods and services
providers and above all customersâ improve as well. This enables the company to
produce qualified goods and services with competitive prices and eventually helps in a
fast and stable growth. Apart from financing, venture capital funds play an important role
in providing consultancy to companies. Due to their vast experience, connections and
business relations, our SMEs are supported for the resolution of various problems in an
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 and network
connections may be even more important than the actual loan. For some entrepreneurs, it
is one of the main reasons to solicit for an investment from an informal investor
The venture capital industry continues to grow entire new industries nearly from 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 âlimited partnersâ in the firmâs funds, which are
typically designated for investment in specific industries (e.g. information technology,
life sciences, clean technology). Venture funds have a life span of approximately 10
years. During the first several years, venture capitalists invest in promising new
companies that then become part of the firmâs portfolio. Over the course of the fundâs
life, these companies are nurtured with the hope that they will be acquired or go public at
a premium to the total amount invested. This process is called an exit.
Making investments at the earliest stages of a companyâs development involves
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 VCâs goal is to
grow the company to a point where it can go public or be acquired by a larger corporation
â at which time the firm and its limited partners may capture their return if the exit is
worth more than the total investment.
Unlike most other investors, venture capitalists provide more than just money. Typically,
VCs take seats on the boards of their portfolio companies and participate actively in firm
management. This often includes connecting the company with resources and expertise
for development and production, providing 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 VCâs responsibility to
their limited partners will require them to walk away.
These elements â the patience, the hands-on guidance, the willingness to take on risk and
fail â make venture capital unique as an asset class. In no other ecosystem are all of the
stakeholders aligned around one simple objective: company growth. This alignment
drives U.S. economic growth and generates more jobs than other asset classes, and it has
set the U.S. economy apart from those of other countries.
Venture capital has numerous advantages to both small and medium sized enterprises
funding is concerned. A part form providing financial support, more 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 companiesâ like
Genentech and Amgen. A decade later, venture funding was growing the software
development and semiconductor industries into prime drivers of the U.S. economy.
Online retailing (Amazon, eBay) followed in the 1990s and clean technology is poised to
extend this legacy today.
According to Black, S. (1998), Exit by IPOs is very attractive to venture capitalists. Many
have argued that VC and investment banks fuelled a disproportionate number of new
firms in sectors with âhotâ 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 VCs driving
waves of new firm creation in nascent industries with windows of opportunities.
Allen, F. and D. Gale (1999), âDiversity of Opinion and Financing of New
Technologies,â Journal of Financial Intermediation, Vol. 8, pp. 68-89.
Allen and Gale (2000), Comparing Financial Systems (MIT Press, Cambridge,
Asian Venture Capital Journal (2002), âThe 2002 Guide to Venture Capital in Asia,â
(available on the Internet at asiaventure.com).
Bascha, A. and U. Walz (2001), âFinancing Practices in the German Venture Capital
Industry: An Empirical Assessment,â unpublished manuscript, University of
Black, S. and R. Gilson (1998), âVenture Capital and the Structure of Capital
Markets: Banks versus Stock Markets,â Journal of Financial Economies, Vol. 47, pp.
BVK (2000), Venture Capital in Europa 1999 (German Venture Capital Association,
Blass, A. and Y. Yafeh (2001), âVagabond Shoes Longing to Stray: Why Foreign
Firms List in the US,â Journal of Banking and Finance, Vol. 25, pp. 555-572.
Botazzi, L. and M. Da Rin, M. (2001), âVenture Capital in Europe: Euro.nm and the
Financing of European Innovative Firms,â forthcoming, Economic Policy.
Carlin, W. and C. Mayer (1999), âFinance, Investment and Growth,â CEPR
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Cornelli, F. and O. Yosha (1997),