Venture Capital

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Definition of Venture Capital:

Venture capital is money invested in companies that do not have access to the capital markets. Normally the companies are start-ups or rapidly growing and require capital to finance their growth. The risks are high, but so is the potential for high returns on investment.

Detailed Explanation:

Do you have a great idea, but not enough money to bring it to fruition? Do banks like your idea, but they are not willing to accept the risk and make you a loan? If so, then you may want to consider venture capital. Venture capital provides the capital needed to begin or expand a business. It is not a loan. Instead, the venture capitalist provides the money needed in the expectation of receiving a share in the profits. A venture capitalist’s ownership interest is normally very high. When reliant on venture capital, a business owner relinquishes a great deal in control and share of the profits. Why would anyone consider venture capital? Perhaps you need money to build a plant to manufacture your product. Maybe you want to expand your market globally. The cost is high, but without the funds, your company’s growth would stall. A small piece of something large may be greater than a large piece of something small. An entrepreneur should consider the expected returns with or without venture capital before choosing whether or not to pursue a venture capitalist.

Venture capital is not debt. In the early stages, a business may not generate much cash to pay a loan. Unlike bank loans, valuable cash is not drained from the company to pay interest. Instead, it can be used to finance future growth. 

For example, Harriet has developed a lipstick that changes color with mood swings. She needs $2 million to begin the manufacturing process and market her product. She expects it to take several years before actually earning a profit, but she projects that her annual profits will exceed $1 million in three years and grow 30 percent between years four and ten. Banks tell Harriet that her business lacks the cash flow, and collateral to provide a loan. They encourage her to return after three years when she is profitable. That does not help her now! Venture Inc. is interested in financing her venture, but it requires a 40 percent ownership interest. They also insist on protecting their investment by controlling many of the most important management decisions. Harriet feels comfortable with this. In fact, she believes the expertise Venture Inc. brings to her company may prove very helpful. She chooses to accept the offer. After all, 60 percent of $1 million is greater than 100 percent of zero. 

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