People thinking of opening a business may view the venture capitalist (VC) as a single individual who is prepared to invest money in a fledgling company, or one that may be on the verge of success. Such a person “ventures” or puts up such money in the hopes of getting a good return on his/her investment. While a few private individuals are wealthy enough to singly provide money to float a company, most venture capitalists work with a group of other investors to invest in a company that has a promising chance of returning them more income within five to ten years of their initial investment.
When a venture capitalist is part of an investment group, he or she is probably not just investing in one business. Instead, the group raises funds to invest in a number of businesses. Even with the best business analysis, not all businesses will succeed. By diversifying, a venture capitalist group has a better chance of turning a profit. When a company is successful, these investors can make approximately a 60% return on their initial investment, and they also own a stake, and possibly a controlling interest, in a company. They may, through the purchase of privately offered stock, be able to direct or influence the course of the company so it stays on the path to success.
Generally the venture capitalist group looks for certain types of businesses in which to invest. These businesses may not have access to loans since they are not as yet proven. Investors can provide seed money for attractive start-up businesses, or early stage investing once a company has begun. Alternately, a company that appears like it “could” be successful might receive expansion stage funds from VC firms or a VC firm could invest in later stages of the company when an influx of cash is needed to expand or keep a business running before stock is publicly offered.
One of the most glamorous ways to make high returns on investments, especially inspired by VC firms during the dot com bubble of the 1990s, was to grow a firm through investment, which would then offer a initial public offering (IPO) of stock. When this stock was sold, it usually represented a huge return for early investors. Even workers in a company might have acquired some stock, and earned quite a bit when stock went public, but venture capitalists definitely earned the most, making millions of dollars as Silicon Valley grew. Of course the flipside was that in the late 1990s, the dot com bubble burst, and venture capitalists still growing businesses lost money by investing in firms that didn’t do as well or were completely unsuccessful.
Another way a venture capitalist can see a return on investment is if a company merges with another company or is acquired by a much larger company. The larger company usually doesn’t want VCs to maintain a controlling interest in the company and the sale or merger buys out VCs offering them a good to sizable return on their investment.
The goal of any venture capitalist is to fund and help grow a business, and then “exit” the business once it becomes profitable by the above-mentioned methods. Usually once the money is invested, it takes several years before investors will see a return, and they don’t generally have access to this invested money until profit is made. Yet since VCs tend to work by diversifying, investments may mature at different times, offering a VC firm a stream of cash for reinvestment and for personal profit.