Venture capital is a special type of private equity fund that wealthy individuals and institutional investors raise to finance specific start-up companies. They are collectively known as ‘’venture capitalists’’. These investors offering the finance scheme believe these corporations have a significant growth potential in the market. They feel that the corporate enterprises’ entrepreneurs will probably introduce a new product or service that revolutionizes people’s lives. In exchange for providing the necessary funds, the investors seek a minority stake in the ownership of the companies. In some cases, the investors even offer to provide technical expertise and managerial assistance to the corporate enterprises.
Kavan Choksi is a businessman with interests in business finance, modern technologies, and photography. According to him, start-up companies need adequate funds to establish themselves in the market and commerce business operations. In the initial stages, the entrepreneurs operating these corporations are able to collect some money for their businesses through bootstrapping. However, the amount might not be enough to compete and outperform other large corporate enterprises. Moreover, many of them do not meet the stringent eligibility requirements to apply for convention loans from commercial banks. The entrepreneurs of the start-up companies often approach venture capitalists to provide them with adequate capital and strategic assistance.
Evaluating start-up companies
Investors who form venture capital funds are selective of which categories of emerging start-up companies they wish to finance. They generally fund corporations operating in specific industrial sectors like telecommunication, software development, biotechnology, and digital marketing. These investors even maintain their own criteria to assess the viability of the prospective start-up companies. They generally scrutinize:
- The experience and previous successes of the entrepreneurs operating the corporations,
- The size of the market where the companies intend to conduct their business operations,
- The initial traction that companies have been able to achieve in generating sales, revenue, and profits,
- The revenue-generating potential and profitability of the start-up entrepreneurs’ business model, and
- The break-even level and capital efficiency of the entrepreneurs’ business model.
How does venture capital work?
Venture capitalists raise funds to invest in start-up companies rather than own money from external sources. These include wealthy individuals having a high net worth, family offices, insurance companies, investment banks, and custodians of pension funds. The capitalists then invest the funds in those start-up companies that they consider to have impressive growth potential. In some cases, they even provide the entrepreneurs of the emerging corporations with skilled manpower, industry-based specialists, and connections. For providing the necessary finance, venture capitalists seek a minority stake in start-up companies and lucrative returns. As board members, they even assist the entrepreneurs in the decision-making process.
According to Kavan Choksi, start-up companies can take their businesses to the next if they obtain venture capital funds. Moreover, venture capitalists are industry-savvy investors who open up new opportunities and connections for entrepreneurs of these corporations. However, these investors will insist on having a minority stake in the start-up companies and high returns on their investment. As a consequence, the entrepreneurs need to ensure the terms of the arrangement are favorable.