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The Venture Capital Industry Overview

Source: National Venture Capital Association

An Overview
Venture capital is money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant economic contributors. Venture capital is an important source of equity for start-up companies.

Professionally managed venture capital firms generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment funds, foundations, corporations, wealthy individuals, foreign investors, and the venture capitalists themselves.

Venture capitalists generally:

  • Finance new and rapidly growing companies
  • Purchase equity securities
  • Assist in the development of new products or services
  • Add value to the company through active participation
  • Take higher risks with the expectation of higher rewards
  • Have a long-term orientation

When considering an investment, venture capitalists carefully screen the technical and business merits of the proposed company. Venture capitalists only invest in a small percentage of the businesses they review and have a long term perspective. Going forward, they actively work with the company's management by contributing their experience and business savvy gained from helping other companies with similar growth challenges.

Venture capitalists mitigate the risk of venture investing by developing a portfolio of young companies in a single venture fund. Often they will co-invest with other professional venture capital firms. In addition, many venture partnership will manage multiple funds simultaneously. For decades, venture capitalists have nurtured the growth of high technology and entrepreneurial communities resulting in significant job creation, economic growth and international competitiveness. Companies such as Digital Equipment Corporation, Apple, Federal Express, Compaq, Sun Microsystems, Intel, Microsoft, Genentech and Google are some famous examples of companies that received venture capital early in their development.

Investment Focus
Venture capitalists may be generalist or specialist investors, depending on their investment strategy. Venture capitalists can be generalists, investing in various industry sectors, or various geographic locations, or various stages of a company’s life. Alternatively, they may be specialists in one or two industry sectors, or may seek to invest in only a localized geographic area.

Not all venture capitalists invest in "start-ups." While venture firms will invest in companies that are in their initial start-up modes, venture capitalists will also invest in companies at various stages of the business life cycle. A venture capitalist may invest before there is a real product or company organized ("seed investing"), or may provide capital to start up a company in its first or second stages of development ("early stage investing.") Also, the venture capitalist may provide needed financing to help a company grow beyond a critical mass to become more successful ("expansion stage financing").

Venture capitalists may invest in a company throughout it’s life cycle and therefore some funds focus on later stage investing by providing financing to help the company grow to a critical mass to attract public financing through a stock offering. Alternatively, the venture capitalist may help the company attract an acquisition offer or create a merger with another company and thereby provide liquidity and exit for the company’s investors and employees/founders.

At the other end of the spectrum, some venture funds specialize in the acquisition, turnaround or recapitalization of public and private companies that represent favorable investment opportunities.

While innovative technology and healthcare investments make up the majority of venture capital investing, venture capitalists also invest in industries such as construction, industrial products, business services, etc. There are several firms that have specialized in retail company investment and others that have a focus in investing only in "socially responsible" start-up endeavors.

Venture firms come in various sizes, ranging from small seed specialist firms with only a few million dollars under management to firms with billions of dollars in invested capital around the world. The common denominator in all of these types of venture investing is that the venture capitalist is not a passive investor, but has an active and vested interest in guiding, leading and growing the companies they have invested in. They seek to add value through their professional networks and experience in investing in tens and hundreds of companies.

Length of Investment
Venture capitalists will help companies grow, but they eventually seek to exit the investment in three to seven years. An early stage investment may take 5-7 years to mature, while a later stage investment may only take a few years, so the appetite for the investment life cycle must be congruent with the limited partnerships’ appetite for liquidity. Venture capital investing is high-risk long term and illiquid in nature and should always be made with careful diligence and full appreciation for the risks.