Venture capitalists support businesses through providing equity funding as they exchange their funding for an organisation with share holding. Most businesses that seek venture capital funding do so because they are considered too risky by banks and other providers of finance, therefore they do not have an alternative source of funding.
What Do Venture Capitalists Do?
In some cases venture capitalists also proactively identify, screen, scrutinise and invest money in companies that meet their criteria for selection as an investment target. Examples of firms that have been subjected to this include high tech firms, bio tech firms and IT firms.
The expectation from the venture capitalists is that at some future date the business will become profitable resulting in payment of dividends and also growth in value of their investment. Ultimately venture capitalists recoup their investment through selling their shares or the whole company to outsiders. Venture capitalism is a high risk business therefore most venture capitalists hold a portfolio of investments to diversify their risks or to neutralise the potential loss from a venture.
What Do Venture Capitalists Finance?
Venture capitalists finance only a tiny number of selective businesses. Each venture capitalist may specialise its funding only on a certain stage of a business life cycle. For example, one venture capitalist may only concentrate on business start ups or on mergers and acquisitions. Below are the main types of venture capital’s funding stages:
- Start up and early stage financing: start up venture capitalists finance product development and usually the firms they fund will not have commenced on commercial production. At this early stage in the life cycle the business will not be generating any profits and will be cash hungry.
- Expansion financing: venture capitalists involved at this stage finance the firm because the firm wants to increase production, increase marketing or invest in product development. Expansion financing may also include recovery funding or refinancing of bank debt.
- Management buy out (MBO) or management buy in (MBI): A management buy out involves the venture capitalist funding a buy out of a company by its current management. A management buy in involve the venture capitalists funding a buy out of company by an outside management team. Both management buy out or management buy in are forms of leveraged buy outs as they are funded wholly or largely by debt.
- Institutional buy out (IBO): In an institutional buy out the venture capitalist provides funding for the acquisition of a company prior to the management team (either the current or incumbent) acquiring a stake in the acquired company.
- Leveraged build up (LBU): An LBU venture capitalist provides venture capital to buy a company with the purpose of making further acquisitions in future. The objective of a leveraged build up is to create a platform for empire building by the venture capitalist.
Venture capitalists have sector preference therefore they usually do not make investments outside their preferred sectors. It is advisable that if a firm is seeking venture capital funding it has to pitch its funding application to the venture capitalists who invest in their industry or sector.
Munya Mtetwa - Munya is an ACCA and IFA qualified accountant with over ten years financial management and accounting experience acquired in a plethora of ...
Join the Conversation