BIZCHINA / Backgrounder
Venture capital
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Updated: 2006-10-18 14:42
Venture capital (VC) is funding invested, or available for investment, in
an enterprise that offers the probability of profit along with the
possibility of loss.
Indeed, venture capital was once known also as risk capital, but that
term has fallen out of usage, probably because investors don't like to
see the words "risk" and "capital" in close conjunction. Venture
capitalists often don't tend to think that their investments involve an
element of risk, but are assured a successful return by virtue of the
investor's knowledge and business sense. DataMerge, a financial
information provider, says that VC investments in an enterprise are
usually between US$500,000 and US$5 million, and that the investor is
likely to expect an annual return of 20 to 50 percent.
Venture capitalists were instrumental in the enormous increase in the
number of dot-com startups of past few years. Because the Internet was a
new and untried business venue with enormous potential, many analysts
feel that standard business rules were too frequently suspended in what
was a very optimistic market. Internet-based enterprises were expected to
enjoy unprecedented success; many venture capitalists were said to have
encouraged dot-coms to focus on scaling upward rather than on realizing
early profits.
According to VentureWire, U.S. venture capital funding for 2000 was
US$105 billion, more than the total funding available in all the 15 years
before that. However, in April of that same year, severe market
corrections brought about a radical change in the financial climate, and
since then online businesses have been failing at rates similar to the
rates of startups in the early days of the dot-com boom. Vulture
capitalist, a term coined in the volatile financial environment of the
1980s, has been revived to refer to the venture capitalists that have
recently begun to buy up failing dot-com enterprises at rock-bottom
prices.
Venture capital is the second or third stage of a traditional startup
financing sequence, which starts with the entrepreneurs putting their own
available funding into a shoestring operation. Next, an angel investor
may be convinced to contribute funding. Generally an angel investor is
someone with spare funds and some personal or industry-related interest -
angels are sometimes said to invest "emotional money," while venture
capitalists are said to invest "logical money" - that is willing to help
give the new enterprise a more solid footing. First-round venture capital
funding involves a significant cash outlay and managerial assistance.
Second-round venture capital involves a larger cash outlay and
instructions to a stock or initial public offering (IPO) underwriter, who
will sell stock in exchange for a percentage of what is sold. Finally, in
the IPO stage, an investment bank is commissioned to sell shares to the
public.
In the currently sober economic climate, a return to traditional business
wisdom has meant that enterprises are generally expected to show a clear
path to profitability if they want to attract investment funds.
(For more biz stories, please visit Industry Updates)
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