Characteristics of Venture Capital
What are some of the characteristics of venture capital? Although it might not be in vogue to draw too much attention to risk, high risk versus high rate of return is certainly one.
What are some characteristics of venture capital? Venture capital tends to represent a rather large investment in a rather small number of carefully selected companies. Venture capital is used for a number of stages in the movement of a company from an idea to a successful idea. These stages range from seed financing that is used to bring the idea to the position of being ready for an actual business start up to bridge financing that is intended to get it through the final period before it goes public with an IPO.
Venture capital is usually associated with high risk/high return investments. Many venture capitalists would not be as quick to use that word to describe the ideal investment. The association of risk with venture capital comes from two sources. First, there is always a basic assumption that all other types of financing have been attempted already. There are some reasons why traditional lending institutions have rejected low interest business loans. These reasons are not associated with the classic idea of risk as a high possibility of failure. More common reasons include a lack of tangible collateral.
The venture capitalist is more likely to view a good idea whose time has come as representing intangible collateral. The second source of the risk idea is that venture capital is drawn to ideas on the cutting edge. Many people view venture capital as an essential element of growth in an economy because it encourages that which is new. New ideas are not always attractive to the traditional and very conservative lending industry that prefers to deal with what is old and tested. Yet, without movement out on the cutting edge of technology and innovation, there will be little growth. New represents as much opportunity for large profit as it does risk of failure.
The rate of return (ROI) of venture capital investments is very high. It can range from 25% to 100%. A ROI below 25% would be considered a poor venture capital investment. The higher than average ROI is another factor in the association of venture capital with risk. The general axiom in investing is the higher the risk, the higher the rate of return. While this is true, the venture capitalist is not that much of a gambler. Investments are closely investigated and very carefully selected.
It is another major characteristic of venture capital that it is not a passive investment. The venture capitalist rarely writes a check and sits back to wait for results. Venture capital involves very active participation in the business being funded. This participation involves direct involvement in management, taking a strong equity position, and bringing value added network resources to bear on the company’s growth and opportunities.