The term ‘venture capital’ is thrown around quite often these days, not only in the financial news but also in discussions related to startups and the technology sector. But what does it mean?
Venture capital is a form of financing often provided to startups and small businesses with high growth potential. Typically, the companies receiving venture capital are in their earliest stages, with many not yet making their product or generating cash flow. Venture capital firms provide that financing by pooling money from institutional and accredited investors who are looking for high returns.
In this quick guide, venture capitalist Ari Stiegler of Flux Capital explains the concept of venture capital, providing a clear understanding of how it works and its benefits to entrepreneurs and startups.
In simple terms, venture capital is a kind of financing where investors provide money to startups and small businesses. Typically, the companies that receive venture capital are the ones that investors believe have lots of potential to grow in the future.
Venture capital is a form of private equity. However, these firms are somewhat different because they focus more on small, emerging companies that aren’t yet fully established.
Many people don’t realize that venture capital isn’t just about money; venture capitalists like Ari Stielger of Flux Capital also provide other forms of support to up-and-coming businesses, like technical expertise and management experience.
Another thing that makes this type of investment interesting is the source of funds. Venture capital firms typically collect funds from institutional and accredited investors who are looking to make a quick return.
Small startups attract the backing of venture capital firms because of their long-term, high-growth potential. They are often working on new and innovative technologies.
These days, providing capital to startups is well-known in the mainstream financial world. However, that wasn’t always the case. There was a time when venture capital was only a tiny niche in the industry that many people didn’t understand very well.
The precise origin of this financial strategy is hard to pinpoint as there are different stories about where it began. However, many agree that the first modern venture capital firm began in 1946, right after the end of World War II. That firm was the American Research and Development Corporation (ARDC), formed by the ‘father of venture capital’ General Georges F. Doriot.
Since then, venture capital flew under the radar until it gained more mainstream attention in the 1990s for supporting tech companies during the Internet boom.
Venture capital can be further broken down into several different types. Typically, the type of backing that a startup might need will depend largely on its current growth stage.
Here are three examples of venture capital backing that a company might pursue:
A company in the pre-seed stage is still trying to turn its idea into a workable business plan. In other words, this is the earliest stage of a high-potential business, which also makes it the one with the highest risk of failure.
At this stage, the support the business needs from a firm like Flux Capital goes beyond just funding. It also needs expertise and mentorship to start bringing its business idea to life.
Seed funding is the next growth stage where a venture capital firm can support a business. At this point, the company exists and is actively trying to launch its first product or service.
The company still hasn’t made any money on its own, so it needs venture capital to fund its operations and keep it running in the meantime.
The venture capital firm might continue providing nonfinancial support at this stage in the form of technical and managerial expertise.
In the third growth stage, early-stage funding, the company has a working product that is ready for sale to customers. However, it still needs financial support to produce and sell the product and eventually turn a profit.
Many startups prefer the backing of a firm like Flux Capital over other forms of financing because it offers significant benefits, such as:
Unlike conventional forms of financing, venture capital firms are willing to work with early-stage companies or entrepreneurs that have high potential, even if they don’t have a working product yet.
Venture capitalists like Ari Stielger enable startups to secure funding and support even without any cash flow or assets. Of course, they must demonstrate plenty of growth potential, such as with innovative technologies that will disrupt the industry.
Venture capital firms offer more than just financial support. Firms like Flux Capital also guide businesses to help them become more efficient and attract the best talents in their sector.
When these benefits come together, they can form the winning combination that an innovative early-stage business needs to succeed.
Venture capital provides startups with the necessary support to fill in the gaps in their experience and get their business off the ground, so that they can achieve exponential growth in the future.
On the whole, venture capital allows small businesses and entrepreneurs to gain support despite not yet manufacturing a product or generating any cash flow. Venture capital firms like Flux Capital and many others support these businesses with funding and mentorship, whether that’s in technical expertise or in managerial experience. Venture capitalists do that because they believe those businesses have plenty of growth potential in the future, making them the perfect opportunity for early-stage investment.