Venture capital is a source of financing for new businesses. Venture capital funds pool investors' cash and loan it to startup firms and small businesses with perceived, long-term growth potential. This is a very important source of funding startups that do not have access to other capital and it typically entails high risk (and potentially high returns) for the investor.

Most venture capital comes from groups 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 a limited operating history that cannot raise capital though a debt issue or equity offering. Often, venture firms will also provide start-ups with managerial or technical expertise. For entrepreneurs, venture capitalists are a vital source of financing, but the cash infusion often comes at a high price. Venture firms often take large equity positions in exchange for funding and may also require representation on the start-up's board.


The Stages in Venture Capital (VC) Investing
Angel investors
are most often individuals (friends, relations or entrepreneurs) who want to help other entrepreneurs get their businesses off the ground - and earn a high return on their investment. The term "angel" comes from the practice in the early 1900s of wealthy businessmen investing in Broadway productions. Usually they are the bridge from the self-funded stage of the business to the point that the business needs true venture capital. Angel funding usually ranges from $150,000 to $1.5 million. They typically offer expertise, experience and contacts in addition to money.
  1. Seed - The first stage of venture capital financing. Seed-stage financings are often comparatively modest amounts of capital provided to inventors or entrepreneurs to finance the early development of a new product or service. These early financings may be directed toward product development, market research, building a management team and developing a business plan.

    A genuine seed-stage company has usually not yet established commercial operations - a cash infusion to fund continued research and product development is essential. These early companies are typically quite difficult business opportunities to finance, often requiring capital for pre-startup R&D, product development and testing, or designing specialized equipment. An initial seed investment round made by a professional VC firm typically ranges from $250,000 to $1 million.

    Seed-stage VC funds will typically participate in later investment rounds with other equity players to finance business expansion costs such as sales and distribution, parts and inventory, hiring, training and marketing.
  2. Early Stage - For companies that are able to begin operations but are not yet at the stage of commercial manufacturing and sales, early stage financing supports a step-up in capabilities. At this point, new business can consume vast amounts of cash, while VC firms with a large number of early-stage companies in their portfolios can see costs quickly escalate.
    • Start-up - Supports product development and initial marketing. Start-up financing provides funds to companies for product development and initial marketing. This type of financing is usually provided to companies just organized or to those that have been in business just a short time but have not yet sold their product in the marketplace. Generally, such firms have already assembled key management, prepared a business plan and made market studies. At this stage, the business is seeing its first revenues but has yet to show a profit. This is often where the enterprise brings in its first "outside" investors.
    • First Stage - Capital is provided to initiate commercial manufacturing and sales. Most first-stage companies have been in business less than three years and have a product or service in testing or pilot production. In some cases, the product may be commercially available.
  3. Formative Stage - Financing includes seed stage and early stage.
  4. Later Stage - Capital provided after commercial manufacturing and sales but before any initial public offering. The product or service is in production and is commercially available. The company demonstrates significant revenue growth, but may or may not be showing a profit. It has usually been in business for more than three years.
    • Third Stage - Capital provided for major expansion such as physical plant expansion, product improvement and marketing.
    • Expansion Stage - Financing refers to the second and third stages.
    • Mezzanine (bridge) - Finances the step of going public and represents the bridge between expanding the company and the IPO
  5. Balanced-stage financing refers to all the stages, seed through mezzanine.
Venture Capital Investment Characteristics and NPV

Related Articles
  1. Small Business

    How To Raise Seed Capital and Grow Your Startup

    To get a business off the ground, entrepreneurs need a clear understanding of how to strategically position themselves for VC firms and angel investors.
  2. Small Business

    How Venture Capital Will Change in 2016

    Venture capitalists face a tech bubble on the horizon, along with an influx of new non-traditional investors via Wall Street and crowdfunding platforms.
  3. Small Business

    Is Equity Financing the Right Choice for Your Business?

    Discover the benefits and drawbacks of equity financing for a small business, and learn when equity financing should be used instead of debt financing.
  4. Financial Advisor

    A How-To Guide to Being a Venture Capitalist

    So, you want to be a venture capitalist? Here's what it takes (besides capital).
  5. Investing

    How Social Venture Capital Is Changing the World

    Learn what social venture capital is and the ways in which it differs from traditional venture capital. Identify two leading social venture capital firms.
  6. Insights

    5 Ways To Get Venture Capital Funding

    Crowdfunding and online networking are just some of the ways you can find venture capital investors.
  7. Investing

    Series A, B, C Funding: What It All Means and How It Works

    Series A, B, and C funding in the field of entrepreneurship and early stage investing refers to the development stages of startups raising venture capital.
  8. Insights

    Is Venture Capital Slowing in the U.S.?

    Venture capitalists are more selective in 2016, turning away from U.S. startups in an era of big business and slow growth prospects.
  9. Investing

    Be Your Own Venture Capitalist With These Stocks

    By doing some digging, there are ways for the average joe to become his/her own venture capital fund.
  10. Small Business

    Small Business Financing: Debt Or Equity?

    There are two sources of financing for small businesses: debt and equity financing. This article explains both.
Frequently Asked Questions
  1. What is the difference between earnings and profit?

    Read about the differences between a company's earnings and its profit, and learn how the gap between earnings and profit ...
  2. Are dividends considered an asset?

    Find out why dividends are considered an asset for investors, but a liability for the company that issued them. Learn the ...
  3. How do I use the IRS Free File tax forms?

    Free File is a way for taxpayers to prepare and file their federal taxes online for free.
  4. What's the smallest number of shares I can buy?

    When buying stocks, many would say the smallest number of shares that an investor can purchase is one, but the real answer ...
Trading Center