Venture capital, often shortened to VC, is a way to fund growing portfolios and startup businesses alike. It involves an entire industry of investing in future businesses, those who have funds and want to gamble on entrepreneurs with a bright future, and ways to jumpstart new ideas or a long-term business plan by backing them with dollars.
Essentially, it’s a form of private equity funding or financing. It has been around for decades but has grown in popularity over the past several years, especially with the startup boom of younger generations.
What sets venture capital apart from a business loan, for instance, is the level of risk that can be involved in spending it. If you’re giving venture capital to others, there is a chance you may never receive those funds back. If you’re receiving funds for your own business, you’re using other people’s money and have to ensure that you are spending it in a smart way.
Venture capitalist firms often lose money. But by betting on those with the most potential, investors are often able to make higher than averages returns on their investments.
It’s a gamble, of course, but by playing it smart, doing key research, and knowing who they are investing in, venture capital firms can earn money back with continued successful investments in portfolio companies or new products.
Here’s how venture capital financing works.
How Does Venture Capital Work?
Venture capital is essentially free money for a business or entrepreneur to spend in a way that both they and the venture capital professionals agree on. It’s not money that the receiver can spend however they want, but rather dollars intended to help grow their business, product development, or idea into greater success.
This process works by allowing the entrepreneur or founder to get where they need to go with guidance and resources. Most of the time, the partnership between the founder and the venture capitalist providing the funds doesn’t end with the money—the entrepreneur or founder is also receiving the expert guidance and knowledge of the venture capitalist professionals to help them succeed.
The funds may be used for obtaining equipment, creating business licenses, conducting market research, hiring employees, creating products to sell, obtaining a patent, and much more. These funds may be provided all at once, but more often than not, they’re provided in rounds as the investor takes an active role in the company.
Who Is Venture Capitalism For?
VC is a great option for new businesses or owners with little clout in capital markets. If they don’t have the necessary funds to start their business on their own or they’re looking to scale up, they can use others’, like those of high net worth individuals, to advance their ideas.
It’s a great way to establish oneself in the business world while making money for yourself, your idea, and your investors or limited partners. Those limited partners are the people who fund venture capitalist firms.
Limited partners don’t manage the day-to-day operations of the businesses that they’re investing in, and they aren’t liable for business debts that exceed the amount of their investment. If a venture capitalist firm is investing in your business or idea, you might have a few limited partners involved.
Ultimately, everyone wins when VC is used correctly.
When a venture capitalist lends their money to the borrower, they have a say in how it’s spent. In the same way that you can make a donation and put stipulations on it, the lender can do the same. They can suggest you spend your dollars in a way they believe will be most beneficial to the company, therefore giving them the best chance at a profitable return.
In many cases, the venture capitalist also obtains a portion of the business when they lend funds. Depending on how much the business is worth, investors will often obtain X percentage of the business in exchange for their money.
Money earned on money spent. That is, after all, how investing goes.
Over time, the lender can sell their equity stake in the business—whether back to the entrepreneur or another investor—or hold onto it and continue to earn on their investment. The ability to sell can also be built into the investment agreement.
Both parties can negotiate for what they want, what’s a sound investment, and what’s best for their business or investment. Experienced venture capitalists will have plenty of chops in this area, while new business owners may not. If you fall into the latter category, it’s best to know your business inside and out and do some research on VC so you aren’t blindsided when going in.
What Happens if the Business Fails?
You may be wondering what happens when a business fails? What if it doesn’t work out and the money is lost? While it’s not common, there is a regular occurrence of investments being lost in the crossfire.
For all involved, it’s a loss. The business owner fails with their business, and the capitalist has lost their funds. There may be some type of agreement as to what happens if the funds are lost, but the money does not have to be paid back in most cases. This is one of the perks of working with a VC rather than a bank.
There are a few reasons this is a rare occurrence. First off, an experienced investor won’t spend money on a project that they don’t believe will be successful. If they have doubts for any reason, especially that the idea won’t take off, it’s unlikely that money will be put in.
Most ventures that lose money are by inexperienced business owners who borrow funds from friends and family members. Because these investors are personally invested in the owner, they may do less vetting or provide more funds than necessary to get a project off the ground. Unfortunately, this can lead to hard feelings between loved ones—so tread lightly.
Another reason that venture capital investments rarely fail is that the investors themselves have much business experience. They are likely to lend their own expertise, due diligence, and connections before they will let their business and ownership stake fail. If a business needs X or Y, they can either offer it themselves or reach out to their connections to help find the required success for moving forward.
They can also put more funds into an operation to provide it with even further growth. If an up-and-coming company needs more supplies or if they run into a financial snag, etc., the VC can either put up more of their own money or ask other investors to help get it to the next level.
In most cases, capitalists do their research and ensure that they invest in good, sound companies or ideas before spending money on a brand.
How To Become a Venture Capitalist
Anyone who has the means can become a venture capitalist. Examples of some venture capital investors include pension funds, insurance companies, and university endowments. All they need is the funds to provide to others and the grit to gamble on a new idea. Having good business sense is also a great step in that it allows you to help budding entrepreneurs when needed.
If you are interested in becoming a VC, talk with others in the field to learn more about what it has to offer and how you can get started.
If you are interested in obtaining funds for an idea that you have, there are many ways you can reach out to other investors. You can use an online platform that brings investors and entrepreneurs together. Or you can talk to those around you and see who may know a guy or find out who has money.
Keep your options open from all ends in order to find the best way possible to either doll out or obtain funds for your business operation. Or your next great idea.
There are plenty of ways for money to be made. Going about it in a smart, effective manner is the best way to create funds for all going forward.
Just because you have never used venture capital in the past doesn’t mean it’s not something you can learn and profit from in the future. Venture capital is a way to fund new businesses or ideas without going through banks or other traditional lenders.
The opportunities provided by venture capitalism, also known as VC, are a great way for founders of new businesses or entrepreneurs to work with established professionals who have the funs and expertise needed for success. It’s a process that allows everyone to profit.
Whether you are interested in investing yourself, want to learn more about how to earn money for an idea, or just want to learn more about the concept, there is plenty for you to take in. Review our previous newsletters and weekly releases to learn more about the world of VC and how you can use this market in the future.
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How Venture Capital Works | HBR
Venture Capital | Venture Capital