Venture capital

Updated: 2006-10-18 14:42

Venture capital (VC) is funding invested, or available for investment, in an enterprise that offers the probability of profit along with the possibility of loss.

Indeed, venture capital was once known also as risk capital, but that term has fallen out of usage, probably because investors don't like to see the words "risk" and "capital" in close conjunction. Venture capitalists often don't tend to think that their investments involve an element of risk, but are assured a successful return by virtue of the investor's knowledge and business sense. DataMerge, a financial information provider, says that VC investments in an enterprise are usually between US$500,000 and US$5 million, and that the investor is likely to expect an annual return of 20 to 50 percent.

Venture capitalists were instrumental in the enormous increase in the number of dot-com startups of past few years. Because the Internet was a new and untried business venue with enormous potential, many analysts feel that standard business rules were too frequently suspended in what was a very optimistic market. Internet-based enterprises were expected to enjoy unprecedented success; many venture capitalists were said to have encouraged dot-coms to focus on scaling upward rather than on realizing early profits.

According to VentureWire, U.S. venture capital funding for 2000 was US$105 billion, more than the total funding available in all the 15 years before that. However, in April of that same year, severe market corrections brought about a radical change in the financial climate, and since then online businesses have been failing at rates similar to the rates of startups in the early days of the dot-com boom. Vulture capitalist, a term coined in the volatile financial environment of the 1980s, has been revived to refer to the venture capitalists that have recently begun to buy up failing dot-com enterprises at rock-bottom prices.

Venture capital is the second or third stage of a traditional startup financing sequence, which starts with the entrepreneurs putting their own available funding into a shoestring operation. Next, an angel investor may be convinced to contribute funding. Generally an angel investor is someone with spare funds and some personal or industry-related interest - angels are sometimes said to invest "emotional money," while venture capitalists are said to invest "logical money" - that is willing to help give the new enterprise a more solid footing. First-round venture capital funding involves a significant cash outlay and managerial assistance. Second-round venture capital involves a larger cash outlay and instructions to a stock or initial public offering (IPO) underwriter, who will sell stock in exchange for a percentage of what is sold. Finally, in the IPO stage, an investment bank is commissioned to sell shares to the public.

In the currently sober economic climate, a return to traditional business wisdom has meant that enterprises are generally expected to show a clear path to profitability if they want to attract investment funds.

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