Venture Capital and How it Works

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Written by VentureXchange

January 17, 2020

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According to the latest Harvard Business Review, more than 80% of venture capital goes into building the infrastructure. A venture capitalist invests in expense in order to grow the business. Therefore, expenses include manufacturing, marketing, sales and other fixed assets.

Why venture money is not a long term solution? The reason behind it is that venture capitalist invest in a company until it grows. Also, your company should reach credibility to be sold to a corporation. Further, institutional public-equity markets can step in and provide liquidity.

The Venture Capital investment profile

A majority of people would say that venture capitalist invest in good ideas. However, the reality is quite different. Venture capitalists invest in good industries. Statista records 9.7 billion US dollars venture capital investment in FinTech and 7.51 billion US dollars in Enterprise software. Moreover, in the Health and Energy sector records show close to 3 billion US dollars and 2 US billion dollars in Food and Marketing.

Furthermore, there is a growing potential in the internet space. However, venture capitalists will avoid early-stage space when the market demand is unknown and technologies uncertain.

In other words, if your business is in a low growth market, venture capitalists are less likely to get backing from a VC. Venture capitalists challenge is to identify entrepreneurs and good management that can deliver. Moreover, the specific industry is engineering where a key challenge is to find entrepreneurs who can advance technology.

As far as it goes, investors of venture capital can always exit if the market or industry is at the edge. In other words, venture capital can be a low-risk type of investment if you know the right time to exit. Besides, should a venture fail, they are the ones giving the right of first claim to assets and technology of the company.

In opposite to the exit strategy, when a company is well-performing, venture capitalists enjoy commissions.

Benefits for the VC

The benefits come in returns on investment for venture capitalists over the years. For a startup company over one to two years, venture capitalists expect the return on capital for ten times more. The real gain receives investors with 80% and the rest is left to venture capital which makes 20% or 30%.  The amount of money any partner receives beyond salary is a function of the total growth of the portfolio’s value and the amount of money managed per partner.

Venture capitalists have to monitor their current deals, but at the same time attract new deals. Also, they should be ready to allocate capital to the most successful deal or assist with exit options.

According to Harward Review, most of the time spent by VC is on serving as directors and monitors. Moreover, if the total time spent with portfolio companies serving as directors and acting as consultants is 40%, then partners spend 800 hours per year with portfolio companies.

Why venture capital is an attractive deal for entrepreneurs?

There are many ups on the entrepreneur side when looking for venture capital fund. However, the far most common mistake entrepreneurs make is that they assume venture capitalists are looking for a good investment idea, rather than skilled management in a specific industry.

Just like VCs, entrepreneurs need to make their own assessments of the industry fundamentals, the skills and funding needed, and the probability of success over a reasonably short time frame.

A very specific for venture-funded companies is that these companies attract talents by “lottery” mentality. Despite the high risk of failures in new business ventures, the majority of skilled engineers or managers leave their jobs because they are unwilling to perceive a high risk of the start-up.

Summary

In summary, we’ve provided you with a short overview of a Harvard Business research on venture capital to help you better understand how venture capital works. Some of the benefits mentioned in this overview for both entrepreneurs and venture capitalists, clarify the reason why venture capital could conclude with a good funding solution. Besides, business entrepreneurs who lack new ideas, funds, skills, or tolerance for risk to start something alone may be quite willing to be hired into a well-funded and supported venture.

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