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What is venture capital and how does it work?


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From Facebook to Uber to Airbnb, many of the world’s best-known and most successful companies have been backed by venture capital. But what exactly is it? In this article we break down the basics of what venture capital is, how it works, and who it’s suitable for. If you’re considering raising finance for your business, this post should help you get an idea if venture capital could be an option.

What is venture capital?

Venture capital (VC) is a form of equity financing where capital is invested in exchange for equity, typically a minority stake, in a company that looks poised for significant growth. A person who makes these investments is known as a venture capitalist.

Technically, venture capital is a type of private equity (PE). But usually the term 'private equity' is used to mean investments made into more mature businesses by PE firms. We explain what private equity is and the differences between PE and VC in our blog post, What is private equity finance and how does it work? 

How does venture capital work?

Unlike angel investors who use their own money to invest, venture capitalists most commonly work for venture capital firms which raise funds from outside investors. These investors, known as limited partners, can include high net worth individuals, family offices, and institutional investors such as pension funds and insurance companies.

VCs use the capital they raise to invest in businesses with high growth potential or businesses that have already demonstrated impressive growth. There are various stages of venture capital funding that reflect the different phases of a company’s development. As start-ups grow, they’ll often go through these stages and raise several rounds of venture capital financing.

Some VC firms have a diversified approach and invest in companies at various stages of the business lifecycle, while others focus specifically on certain stages. For example, seed stage investors help early-stage start-ups get off the ground, while late stage investors help established companies continue their expansion. Many VC firms also specialise in making investments within a particular industry or industry vertical.

With VC financing, businesses can often obtain large amounts of capital. In addition to this, the right investor adds value to the company by providing skills, experience, and connections. As part of a VC deal, an investor will often want to join the company’s board as either an official board member or board advisor. That way, they’re involved in the company’s strategic (and sometimes operational) decisions, and can play an active role in helping it become successful.

Is venture capital right for your business?

VCs are best known for financing technology companies because of their tendency to scale easily, but they invest in non-tech businesses too. What all venture-backed businesses have in common is that they’re oriented towards rapid and significant growth. VC is most suitable for entrepreneurs with big ambitions who don’t need to retain full control of the company as it grows.

These are a few things investors look for when evaluating a business:

  • Solves a strong customer pain. The product or service shouldn’t just be a ‘nice-to-have’; it should solve a problem and create real value for customers.
  • Exit opportunities. There has to be a potential way for the VC to exit so they can realise returns and get the money back to their own investors.
  • Scalability. VCs look for companies that can increase sales and grow in a cost-effective and efficient way.

 

If you’re a tech start-up and want to know more about what key qualities attract an investor, read our blog post, What do investors look for in a tech start-up?

Funding for tech companies

Our Technology Venture Investments (TVI) team invest in businesses that are looking to develop and exploit technology. We work with companies from the start-up stage through to exit, offering entry equity investment of between £50,000 and £2 million, and up to a maximum of £5 million per round. Our aim is to give the companies we support a competitive advantage and create long-term value. We can also co-invest alongside other funding sources such as venture capital firms.

Find out more about the funding we provide by going to our page, Finance for tech ventures.