A venture-capital-backed IPO refers to the selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative to an IPO for a venture-capital-backed company is an acquisition (getting purchased by another company). Both options are known as "exit strategies" because they allow venture capitalists and entrepreneurs to get money out of their investments.

Breaking Down Venture-Capital-Backed IPO

Multiple sources regularly report on both venture-capital-backed IPOs and M&A volume. In lean economic times, there tend to be fewer venture-capital-backed IPOs because of low investor confidence. As a result of the financial crisis, 2008 and 2009 saw record low numbers of venture-capital-backed IPOs. Examples of companies that were once venture-capital-backed IPOs are Tesla Motors and Open Table.

What is Venture Capital?

Venture capital (VC) is a type of private equity, a form of financing provided by firms or funds that judge a company to have high growth potential or which have demonstrated high growth. Venture capital firms or funds invest in these early-stage companies in exchange for an equity stake. Venture capitalists take on these associated risks in the hopes that some of the firms they support will become successful.

The typical venture capital investment occurs after an initial "seed funding" round. The first round of institutional venture capital to fund growth is called the Series A round. Venture capitalists provide this financing in the interest of generating a return through an eventual "exit" event, such as the company selling shares to the public for the first time in an IPO or doing a merger and acquisition (also known as a "trade sale") of the company.

In addition to angel investing, equity crowdfunding and other seed funding options, venture capital is attractive for new companies with a limited operating history that are too small to raise capital in the public markets and have not reached the point where they can secure a bank loan or complete a debt offering.

Venture Capital Funding vs. Debt or Loan Financing

Attracting venture capital is very different from raising debt or a loan. While lenders have a legal right to interest on a loan and repayment of the capital irrespective of the success or failure of a business, venture capital invested in exchange for an equity stake in the business carries no such legal protection and is speculative in nature. The return on a venture capitalist's investment depends entirely on the growth and profitability of the business.