The venture capital fund earns money by owning equity in the companies it invests in. This option is attractive to companies with a limited operating history who are too small to raise capital in public markets or who are unable to secure any bank loans.
How does it work?
As the investors in venture capital and private equity finance are taking a high risk, they are often given a high level of say in the running of the company as well as owning a significant share of the business.
The level of ownership that investors get in the company is the key differentiating factor between private equity and venture capital funding. While venture capital firms invest in 50 per cent or less of the company’s equity, private equity firms tend to invest in a higher percentage.
What do businesses gain?
As a result, venture capital firms prefer to spread out their risk investing in larger number of different companies.
A benefit that this has for smaller companies is that they can benefit from the experience of the investors. As well as providing money for the companies, the investors are expected to bring a wide range of managerial and technical skills to the deal – in a similar way to angel investors.
In general the amount of money invested by a venture capitalist or venture capital fund will be significantly more than an angel investor and often the funds will have a fixed life (generally ten years).
Where the money comes from
The money for venture capital funding or private equity funding often comes from high-net individuals whose focus is to encourage growth while making a profit, and the investment is often managed by funds.
This refers to an organisation that invests the financial capital of third party investors that are considered too risky for the current market place. These firms will then employ individuals with technology backgrounds (scientists, researchers), business training and/or deep industry experience in order to maximise the potential return of the investment.