Private equity operates with high financial risk.
Venture capital is a type of investment that consists of financing companies or projects with significant growth potential but also with a high degree of uncertainty . This type of financial activity is carried out in companies that are not listed on the stock exchange.
Before moving forward, it is necessary to mention that the concept can refer to different financial strategies. In its broadest sense, the notion refers to both early -stage investment and late -stage investment, thereby encompassing what is known in English as venture capital and private equity .
Characteristics of venture capital
Beyond the breadth that may be given to the expression, venture capital usually consists of the financing of a venture or an unlisted company with the intention of boosting its growth . It is a temporary participation that is based on the purchase of a high percentage of shares to achieve control . With this majority participation, the shareholders of the venture capital investment fund can become involved in the management.
It must be taken into account that, when the company has already increased its value and achieved the desired profitability , the exit strategy is launched to end up transferring the stake. This can occur in the medium or long term.
Seed capital is one of the types of venture capital.
Its operation
The most common thing is that venture capital works through investment funds , whose administration depends on a management company . Although the regulation depends on each country, generally these companies have to be registered with an official body that supervises the securities market. To enter the capital , the venture capital company chooses the company in which to invest, raises the funds among its partners and finally completes the investment through a fund.
Another possibility is the intervention of so-called angel investors , who finance startups or emerging companies ( scale-ups ) to achieve a stake in them. These investors act on their own, without being part of a company.
Once the disinvestment ( exit strategy ) is decided, the exit can be expressed in different ways. Shares can be sold on the stock exchange if the company chose to go public with an IPO (initial public offering) or transferred to a third party through a private transaction. In some cases, there is the possibility that the founding partners of the company decide to buy back the shares they had given up when the venture capital came in.
Venture capital is an alternative for an institutional investor.
Types of venture capital
As we have already indicated, the venture capital investment strategy can be carried out in different instances or stages.
Seed investment makes it possible to acquire a percentage of the capital of a company that is taking its first steps. When the company is still in its initial stage but already shows high growth potential, risk capital is referred to as venture capital .
One more possibility is that an investment is made in the expansion phase : in this case, we talk about growth capital and it aims to support the development plan. Unlike what generally happens with venture capital, the growth capital methodology contemplates a minority participation.
The investment
Given that venture capital usually seeks to obtain control of the company it will finance, the minimum investment tends to be very high. That is why it is said that venture capital is an alternative aimed at institutional investors.
There is a chance to make an investment in risk capital assets by using a fund of funds , which distributes the capital into different funds. This provides two great advantages: on the one hand, the investment is diversified, also reducing risk; On the other hand, the minimum investment is lower. However, it is still an operation for those with extensive assets.
Another issue to consider is the deadline . Venture capital never operates in the short term, but is managed with periods of five years or more. Even the disinvestment strategy can be extended for five years.
Likewise, the lack of liquidity of risk capital cannot fail to be mentioned. After the resources are raised, the fund is closed and a period is set in which there are no refunds. Normally only after the fourth year does the fund begin to pay the investor with the money derived from the sale of other shares or dividends.
Benefits of venture capital
According to finance experts, venture capital helps boost the growth of the economy. By financing companies that are not listed on the stock market, they promote their development, promoting an increase in productivity and sales.
Likewise, venture capital contributes to the creation of jobs . When an early-stage company accesses capital, it has the necessary resources to expand its workforce. Another benefit of venture capital is that it encourages innovation . Due to all the characteristics mentioned throughout this article, it is common for venture capital to be allocated to technology companies that present an original business model or that create disruptive products or services.
By financing companies with a lot of growth potential but at the same time with high risk, this strategy usually promotes the progress of new economic sectors. For this reason, it also encourages other investments, since more investors or funds want to intervene in these growing sectors.