Venture capital (VC) is a type of private equity, a form of financing that is provided to small, early-stage, emerging firms that are deemed to have high growth potential, or which have shown high growth (in terms of number of employees, annual revenue, or both). Venture capital funds invest in these early-stage companies in exchange for equity–an ownership stake–in the companies they invest in.
The start-ups are usually based on an innovative technology or business model and they are usually from the high technology industries, such as Information technology (IT), social media or biotechnology. The typical venture capital investment occurs after an initial “seed funding" round. The first round of institutional venture capital to fund this is called a Series A round. In addition to angel investing, equity crowdfunding and other seed funding options, venture capital is attractive.
Obtaining venture capital is substantially different from raising debt or a loan. 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 is invested in exchange for an equity stake in the business.
The return of the venture capitalist as a shareholder depends on the growth and profitability of the business. This return is generally earned when the venture capitalist “exits" by selling its shareholdings when the business is sold to another owner.
Most venture capital funds have a fixed life of 10 years, with the possibility of a few years of extensions to allow for private companies still seeking liquidity. The investing cycle for most funds is generally three to five years, after which the focus is managing and making follow-on investments.
This model was pioneered by successful funds in Silicon Valley through the 1980s to invest in technological trends broadly but only during their period of ascendance, and to cut exposure to management and marketing risks of any individual firm or its product.
Venture capital, as an industry, originated in the United States, and American firms have traditionally been the largest participants in venture deals with the bulk of venture capital being deployed in American companies. However, increasingly, non-US venture investment is growing, and the number and size of non-US venture capitalists have been expanding.
Venture capital has been used as a tool for economic development in a variety of developing regions. In many of these regions, with less developed financial sectors, venture capital plays a role in facilitating access to finance for small and medium enterprises (SMEs), which in most cases would not qualify for receiving bank loans.