There seems to be a lot of talk about ‘venture capital’ among entrepreneurial circles these days, but what is venture capital? Venture Capital is a type of funding given to young, high-risk, high-return companies in their start-up phase. It became popular due to the success of internet startup companies but funding for other industries such as business, service, and agriculture are also sources of investment. Venture Capitalists (VC’s) are investors, (often in a group/firm) who pool together funds of different investors to provide the funding sought after by these start-up companies asking for the VC’s help. 

How do they operate?

These VC investment firms are able to mitigate their risks by investing in a diverse portfolio of different companies. Some companies will focus their investments in related industries (like technology or information) or have a very wide variety of investments (e.g. food, innovation, technology, service), in their portfolios, spreading their risks in different industries. There are also VC companies that look for companies that are planning to make an Initial Public offering to sell their stocks on the stock exchange, allowing VC investors more liquidity in their investment, allowing for a quicker return on their investment. As these types of investments are very risky their reward is also very high, allowing for aggressive growth.

How are they funded?

Venture capitalists often ask for stocks in the company they invest in, allowing them some say in business decisions. Those looking for large investments may be happy to give some stocks away due to the high startup costs, but others see this as a disincentive. Due to the high risk involved in VC funding, some companies also offer mentoring, business connections, and other resources other than money to to help start the business off right.

Venture Capital investment is very popular with internet-based companies due to large advertising and initial capital expenses. They need to attract visitors to the site, acquire equipment, and pay for labor, using up a lot of resources which aren’t immediately available for most people. Yet, as websites are easy to create and be put up for Initial Public Offering, they are popular targets for VC’s.

How do they differ?

There are still many more complicated aspects about VC’s than what meet the eye. The SEC has set limitations on what can be considered a “venture capital fund”. The limits talk about how the fund should be represented to its investors, allotting limits on how the capital is used for certain purposes, restricting the immediate withdrawal of capital, and the registration of the company. VC funds enjoy an exemption from registration thanks to the Investment Advisers Act, but only if they truly qualify as a venture capital fund.