Understanding Venture Capital and Venture Capitalists

Venture capital is a very specific type of investment for a very unique type of company. Venture capital–backed companies are expected to grow extremely fast — much faster than other companies. In addition, VC-backed companies are sold after five or seven years in an acquisition or on the stock market in an initial public offering (IPO).

VC-backed companies have the potential to make millions (billions?) of dollars for investors and founders. Because of the huge windfall possibilities, a lot of people are interested in creating companies that are attractive to VCs. Nevertheless, venture capital is not a necessary part of building or growing your business. In fact, companies can do very well without venture capital and the involvement of venture capitalists.

Technically speaking, venture capital is just like any other investment, an asset class. Venture capital investments are high risk and also potentially high return. Not all investors want to be involved with venture capital (sometimes called risk capital) because of the level of risk involved.

Venture capitalists are the people who invest the money in start-up businesses. Venture capitalists are the professional investors who give start-up companies money in exchange for equity in the company. They provide both liquid capital and support for a company during a fundamental time in the growth of the business.

Venture capitalists are responsible for bringing together large amounts of money for an investment fund (called raising a fund), which is then used to invest in companies, hand-picked to become part of the VC’s (or VC firm’s) portfolio. The VC and his team choose companies that are capable of growing very large very fast, earning the VC firm many times its initial investment.

Venture capitalists know that not every company in their portfolio will produce a huge return on investment, and so to tip the hand in their favor, VCs do two things:

  • They invest in companies that have excellent odds of being successful venture-quality companies.

  • They support the companies in their portfolio with resources like mentorship, board members, and strong management.

Companies that work with venture capital give up an element of control in exchange for the opportunity. Most founders find the exchange worth it for the added capital, support, and connections that come with an investment of venture capital.

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