The simplest way to explain venture capital investing is that it is when an investor, or multiple investors, gives money to a startup company with growth potential in exchange for partial ownership of the company. For companies in their early stages, who do not have enough capital to acquire a business loan or offer stock, this type of investment is essential to funding their operations. For investors, it represents the opportunity to for high returns on their investment due to the capricious nature of startup companies. There are three different stages to the process.
At this point, an inventor or entrepreneur has an idea, but little cash flow to make it a reality. The project is in the conceptual or early development stages and is not yet a functioning business. Seed-stage investments tend to be relatively conservative. Investors often help guide the entrepreneur towards creating a business plan, developing his or her product, conducting market research and building a team of personnel to get the business up and running. The business owner has to have a very impressive idea to attract the attention of venture capitalists this early.
Startups are when the creator of a product has a business structure in place, but may or may not be commercially selling their product yet. These types of businesses are starting to seek revenue, but have not yet earned significant profits, if any at all. This also includes the period that some investors refer to as “first stage” when the company is just beginning to enter the marketplace. This also when many venture capitalists start showing serious interest in an enterprise. The startup phase commences when investors help the business owner get the product out for sale.
Businesses reach this stage after they have been operating a while, typically three years or more, and have shown potential for revenue growth. The company may or may not yet be showing a profit. At this point, investors may provide money for physical expansion plans, marketing and further product development. This also includes the mezzanine, or bridge, stage in which investors help propel the company towards being able to make an initial public stock offering. Typically, the venture capitalists involved in expansion have previously invested in the business.
Many ideas that entrepreneurs turn into fully operational businesses cannot get off the ground without the help of venture capitalists. Although an entrepreneur may raise some money to set his or her project in motion through other sources such as crowdfunding, he or she will usually need to seek out venture capitalists or angel investors before starting commercial production in order to gain substantial market share. For venture capitalists, this represents a chance to get in early and, hopefully, invest in a business that will yield long-term profits.