In this article, we will discuss:
What is Venture Capital?
Venture capital represents an private financing modality, aimed at the financial support of nascent and small companies that have potential for long-term expansion. This form of investment is often provided by angel investors, investment banks and financial entities, and may include, in addition to capital, technical and administrative support.
How Venture Capital Works
Venture Capital is intended for financial support in startups and small enterprises identified by investors as having high growth potential. Generally, investment occurs through private equity, with investors acquiring equity stakes through limited partnerships. This type of investment is particularly focused on emerging companies, differentiating itself from private equity, which is more aimed at already established businesses in search of additional capital. For startups without access to capital markets, loans or other forms of debt financing, venture capital emerges as a vital alternative for raising funds.
Georges Doriot, professor at Harvard Business School, is widely recognized as the “Father of Venture Capital”. In 1946, he founded the American Research and Development Corporation, raising an initial fund of US$3,58 million for investment in companies that commercialized World War II technologies.
The corporation's first investment was made in a company with projects to use X-ray technology in the treatment of cancer, an investment that, from US$ 200 thousand initially, increased in value to US$ 1,8 million with the company's IPO in 1955.
Venture capital gained prominence especially in promoting technological ventures in Silicon Valley, on the West Coast of the United States. In 1992, around 48% of total investments were directed to companies in this region, while the Northeast of the USA concentrated 20% of investments.
In 2022, deals on the West Coast represented more than 37% of total volume, while the Mid-Atlantic region comprised approximately 24% of transactions, according to data from the National Venture Capital Association in the “Pitchbook-NVCA Venture Monitor Q4 2022” report. .
Types of Venture Capital
- Pre-seed Stage: Represents the initial phase of a venture, in which the founders seek to transform an idea into a viable business project. They often seek support from business accelerators for preliminary funding and guidance.
- Launch Financing: At this stage, the objective is to introduce the company's first product to the market. Without established revenues, the startup depends on financial support from venture capital investors to sustain its operations.
- Initial Phase Financing: After developing a product, the company needs additional capital to expand production and sales, towards financial sustainability. This usually involves one or several rounds of investment, called Series A, Series B, etc.
How to Secure Venture Capital Financing
Submitting a Business Plan
Startups interested in raising venture capital must present a detailed business plan to investors or venture capital firms. These potential funders will conduct a due diligence analysis, evaluating the startup's business model, products, management team, and operational history.
Investment Commitment
After due diligence, the investor or venture capital firm commits to investing a specific amount in exchange for an equity stake. Although financing may be available in a single installment, it is common for it to be distributed over several phases. The investor or company plays an active role in the startup's development, providing guidance and monitoring its progress before releasing additional funds.
Investment Exit
The investor seeks to divest from the startup after a period, generally four to six years, through a merger, acquisition or initial public offering (IPO).
Advantages and Disadvantages of Venture Capital
Benefits
- Provides the capital needed for early-stage startups to launch their activities.
- Startups do not need cash flow or assets to qualify for funding.
- Mentoring and networking support from investors helps startups recruit talent and grow.
Disadvantages
- It may result in the loss of a significant portion of the company's controlling interest.
- Startups can lose creative autonomy as investors seek to quickly maximize returns.
- The pressure for immediate returns can lead investors to favor premature exit from the business, to the detriment of long-term sustainable growth.
Angel Investors
Venture capital financing can originate from high net worth individuals, known as angel investors, in addition to companies specializing in venture capital. The National Venture Capital Association is an entity that brings together firms dedicated to financing innovative initiatives.
Angel investors are a heterogeneous group, often made up of businesspeople or retired executives who have accumulated significant wealth. These investors prefer well-structured ventures, with robust business plans and potential for significant growth.
These financiers tend to invest resources in sectors of their expertise, making it easier to identify promising opportunities. They often engage in co-investments, associating themselves with trusted colleagues or partners to support new businesses, expanding the support network for the financed venture.
Venture Capital Success
The deep link with Silicon Valley meant that most venture capital investments benefited the technology sector, covering areas such as the internet, healthcare, hardware, IT services and telecommunications. In 2023, the San Francisco region stood out for the volume of venture capital investments.
Companies from other sectors, such as Staples and Starbucks (SBUX), also benefited from this type of financing. Technological giants, such as Google and Intel, have created their own funds to invest in emerging technologies. In 2019, Starbucks announced the creation of a US$100 million venture capital fund aimed at startups in the food sector.
The venture capital ecosystem has evolved, encompassing a diversity of participants and investment modalities, supporting startups at different stages of development.
Conclusion
The world of venture capital plays a crucial role in the global business ecosystem, providing not only the financing needed to transform innovative ideas into thriving companies, but also offering the expertise and network that can be decisive for the success of startups. Through different stages of financing, from pre-seed to more advanced stages, angel investors and venture capital companies bet on the growth potential of new ventures, taking on significant risks in exchange for the possibility of substantial returns.
The evolution of the venture capital industry reflects the adaptability and dynamics required to meet the demands of an ever-changing market, marked by rapid technological advances and an increasingly interconnected global economy. The inclusion of favorable regulations, such as the Small Business Investment Law and adjustments to tax laws, served to further stimulate the growth of this sector, highlighting the recognition of its value for both innovation and economic development.
However, venture capital is not without its challenges, including the need to balance the pursuit of financial returns with sustainable support for new business development. Startups, in turn, face the challenge of maintaining their vision and control while benefiting from the financial and strategic support that venture capital investors provide.
FAQ
Why is venture capital important?
Startups generally face high risk and require considerable initial investment. Venture capital distributes the risk associated with the business, offering entrepreneurs the chance to carry out their projects in exchange for a significant equity stake at advantageous prices. Essentially, venture capital enables new businesses to launch and realize their visions of the future.
What does late stage investment mean?
Advanced-stage financing has gained popularity because it attracts institutional investors interested in projects with lower risk compared to the initial stages, in which uncertainty about the success of the venture is greater.
How have regulatory changes boosted venture capital?
The Small Business Investment Act of 1958 and subsequent amendments to tax and pension legislation provided significant incentives for venture capital investment. Reducing the capital gains tax and allowing pension funds to invest in emerging companies were important catalysts, leading the 1980s to a period of intense expansion in venture capital financing.
