Venture capital is the financing invested in small businesses and startups that have a high potential for growth. Previously, Anand Jayapalan had spoken about how the goal of a venture capital investment is to deliver high returns for the venture capital firm, typically in the form of an acquisition of the startup or an IPO. Venture capital investments can be a good financing option for startups wanting to quickly scale big. As these investments tend to be quite significant, they can help startups to effectively grow and expand.
In addition to providing funding, venture capitalists also bring a lot of business and institutional knowledge to the table. They are well-connected to numerous businesses, investors and industry leaders which can significantly help a startup. Through their connections, a startup may get additional investors.
One of the biggest reasons why entrepreneurs like working with venture capital firms is that if their startup goes under, they shall be not on the hook for the money. Unlike a loan, there is no obligation to pay the money back in case of venture capital investments. However, this does not mean that venture capital firms do not expect a return on their investment. A part of what venture capitalists want in return for their investment is equity in a startup. This basically means that the entrepreneur has to give up part of their ownership as they bring on venture capital. Depending on the deal, a venture capital might also end up with a majority share of a startup. In case this happens, one would lose the management control of their company.
It is vital to remember that a startup that accepts money from venture capitalists should ideally be planning for an exit of some kind, through an acquisition or an IPO. If an entrepreneur does not have such goals or plans to run the startup forever, then opting for a venture capital might not be a good idea.
A venture capital firm is typically managed by a small group of partners who have secured a significant amount of capital from a pool of limited partners (LPs) to invest on their behalf. The LPs can be large institutions that seek substantial returns on their investments through the services of the venture capital firm. These partners operate within a time-frame of seven to ten years to deploy investments and, crucially, to generate significant returns. Achieving substantial returns within this limited time-frame requires investing in opportunities with the potential for significant outcomes. These sizable successes not only yield substantial profits for the fund but also serve to offset the losses incurred from the inherent risks associated with high-stakes investments.
Earlier, Anand Jayapalan had mentioned that even though venture capital firms typically have large sum of money, they usually invest that capital in a relatively small number of deals. It is common to find a VC with more than $100 million capital to manage less than 30 investments in the entire lifetime of their fund. This is due to the fact that after every investment is made, the VC partners try to focus on managing that investment for up to 10 years.
