How Does Venture Capital Work?


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When starting up a business, one thing virtually every business owner runs into is a need for funding. There are a few ways one can acquire these funds, like dipping into personal savings, taking out bank loans, or through traditional stock sales. But, for a lot of money fast, one approach that is increasingly popular in the Internet age is venture capital. But what is it and how does it work?

Venture Capitalism has found its niche in recent years in funding Internet startup companies, though they have been used to fund a variety of other types of business, as well. Typically a Venture Capitalist (or VC, as they are often abbreviated) will be part of a group of investors in a fund administered by an investment firm. The VC firm will use the pooled funds of the various investors to provide the capital needed by the company seeking the VC's help.

VC investment firms usually diversify their portfolio by investing in a number of different companies to mitigate their risk of loss. Often these companies will all be in a similar industry (for example, biotech or dotcom startups), or they may attempt a truly diversified approach, spreading investments among different industries. Some VC funds also pursue companies that are preparing to make an Initial Public Offering (IPO) where they will be selling their stocks on a publicly traded exchange, giving the VC investor an opportunity to liquidate their investment and make a return on their investment in a matter of months. Investors in venture capital are (or should be) aware of the risk involved, which is why they often use diversified investment strategies. But, with these risks often come great rewards, making VC investments attractive to some seeking aggressive growth in their financial portfolio.

From the company's perspective, venture capital works by giving stock in the company to the VC investor. This gives the VC a bit of control over the business affairs of the company in which it is investing. This can be either an acceptable tradeoff for a large amount of seed or growth capital, or a reason some companies may decide to avoid venture capitalists for their financial needs.

Some venture capitalists can also offer more than just money to the companies in which they invest. this might include industry contacts or business experience and insights.

These types of investments have become popular with dotcoms, given their need for significant upfront advertising and build expenses. They need to advertise to attract visitors and they need to acquire equipment and labor to get the site built in a timely fashion. Many eCommerce sites can consume between $50 and $100 million just to get to the point to go public, and half of that can be spent on advertising. But, given the relative speed with which a site can be built and get to the point of IPO, they are attractive to venture capitalists and these types of company find venture capitalists immensely useful in many cases.

If you would like more information about how venture capitalism works, you should contact an attorney in your area that focuses their practice on business and/or securities law or speak to an investment expert. You can find a list of attorneys in your area by visiting the Law Firms page of our website at HG.org.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.

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