Loading
What is Venture Capital?
Venture capital is money that is invested in new or high-growth companies. New companies seek venture capital as a means of establishing a funding base. An existing company may seek venture capital as a means of creating a new funding stream for a new project, additional product line, or for some other reason that has arisen.
A new company may seek this type of funding to provide a financial foundation; the company could use this foundation to begin operations, including establishing a premises, hiring employees, purchasing equipment, and so on. As noted above, this type of funding can also be applicable to existing companies. For example, a company that manufactures toys for infants and toddlers may seek venture capital to begin research and development work on a line of toys for older children.
Companies seeking venture capital are basically seeking stockholders. A venture capitalist, then, is one who invests in a company by purchasing stock in that company. A venture capital transaction may involve two or more key players: if the investor is acting on his or her own behalf, the scenario would involve the company and the investor. If the investor is represented by a financial advisor of some sort, the advisor would be an additional player.
Venture capital transactions have potential costs and benefits for both the company and the investor. When the company invites investors to purchase shares, it dilutes the power base and the dividends because both must be shared, to some degree, with those who have invested venture capital. However, the company benefits because the venture capital provides a new income stream. Venture capital investors, when they purchase shares, obviously no longer have the freedom to spend that money elsewhere. They can benefit, though, if the company is successful enough to pay substantial dividends. The flip side is that dividends may not be realized if the company is not doing well or has an unprofitable year. Those who deal with venture capital are generally familiar with these costs and benefits and conduct cost-benefit analyses to help them determine whether a particular investment is worthwhile.
Although all companies do their best to be successful, profitable, and strong, this is especially true for companies seeking venture capital. Officers of companies seeking venture capital are fully aware that investors examine various aspects of the company and conduct all sorts of cost-benefit analyses prior to making a decision to invest. A company that is profitable, strong, well-managed, and healthy overall is far more likely to attract venture capital than a company that is struggling to pay employees, poorly managed, and on the verge of closure.
These transactions can be winners or losers for the company as well as the investor. Although there are risks inherent in any type of investment, the investors are generally well versed in determining which companies are good risks for their particular investment dollars. The companies know the potential upsides and downsides of attracting new investors; sometimes the potential downsides, whatever they may be for a particular company, are outweighed by the prospect of a new funding stream.