Surely in recent times you have heard on more than one occasion the concept of “venture capital”, but do you know exactly what it is and what advantages it offers you? If you have a small or medium business that is starting to emerge, take good note because you are interested in venture capital.
Venture Capital Definition
Venture capital is a source of business financing, which is primarily aimed at small and medium enterprises. It is that an investment company provides permanent capital to one of these small or medium-sized companies that are starting. Through this contribution of money and for a limited period of time, investors become part of the group of shareholders of the company in which they have invested, although with a secondary role.
These new companies or receiving societies have to resort to this type of financing, since having no results are considered risky and it is much more difficult for them to access other types of financing. On the other hand, the investment companies have a great interest in the growth of their company, that is why they look for societies that can grow rapidly and that have innovative business models (therefore, that ensure a good return once they start working) and that, in addition, they are in an early stage of development.
In addition, venture capital has benefits for small businesses: if a large prestigious company invests in it, it will be a great asset for customers and suppliers, as they will see it as a trustworthy company that will succeed.
The most important concepts of finance that every manager should know
Characteristics of Venture Capital
Some of the features that define and differentiate venture capital from other types of financing are as follows:
- Venture capital is basically a financing instrument through which a company obtains the capital resources necessary for the development of its startup or growth projects.
- The investment company makes its contribution by participating in the company’s capital stock, either with the purchase of shares or the acquisition of other equity instruments.
- This instrument is normally aimed at SMEs, as there are high risks inherent in their projects and this makes access to more common instruments difficult.
- Being mainly aimed at SMEs, it becomes an efficient channel to direct the excess savings of investors towards financing this type of company.
- Therefore, it can be concluded that investment companies are willing to assume a greater risk than other lenders.
- These capitals of the investment companies, are mainly destined to ventures in first phases or growth projects.
- The concept of venture capital is associated with companies with projects, which involve technological innovation, although it is not imperative.
Types of Investment in Venture Capital
Depending on the development phase of the company, there are different types of venture capital investment:
This type of investment is related to companies that, or have just been born, or, have not yet started their business activities, and their products or services are in the definition phase. This capital is usually used for preliminary expenses such as: market research or product development or prototype testing. The capital resources needs are usually lower than those of the other phases.
As in the previous type of capital, these investments are aimed at companies that have not yet started with the production and distribution of the product or service, in newly created companies and, therefore, have not yet generated benefits. These investments usually have a long maturation period and require subsequent capital injections to finance growth.
Capital for expansion
This type of investment is made in companies that already have some path or trajectory and seeks to make possible the growth of the company’s participation in an already reached market, or its introduction into a market that it had not yet accessed. The fact that the investee company has a previous route, reduces uncertainty and therefore the risk of its operations, by having the existence of historical data, relationship with financial entities, suppliers, customers, regulatory entities, among others.
Acquisition with leverage
Under this modality the acquisition of a company is carried out, for which a significant amount of borrowed money (bonds or loans) is used, which covers the acquisition costs. Often, the assets of the absorbed company are used as collateral for loans, in addition to the assets of the absorbing company, in order to allow companies to make large acquisitions without having to commit significant amounts of capital.
A situation in which a company, which has had poor results for a prolonged period of time, requires financing to make a change in the orientation of its business activities.
In this type of operations, the investment company, when acquiring a position in the receiving company, does not make a contribution of new capital, that is, there is no increase in the capital available to the company. Venture capital is limited to relieving one or more shareholders who are not interested in continuing their investment. The shareholder that is replaced is normally passive, with which the operation aims to generate new dynamics in the company. It is a frequent operation in family businesses.