Venture capital is a form of capital that is provided to early stage and high growth companies, also known as "startups". The key characteristic of venture capital is the high level of risk associated with the investments. Venture capital firms are a very important source of funding for new businesses, because small businesses usually do not have access to capital markets (too small) or bank debt (too risky).
Where does the money come from?
Independent venture capital firms are essentially pools of money coming from institutions and wealthy individuals. These individuals are often successful entrepreneurs themselves who have cashed out of a business and would like to reinvest their cash in sectors they know well. The money is typically managed by a team of ex-entrepreneurs, consultants, bankers or industry experts that will spend time looking for the next Google or Facebook. There are also corporate venture capital arms, most often owned by large technology or healthcare companies. The money comes from the parent company; for example, a large healthcare company would frequently invest in startups that have new ideas for medical devices or new drugs.
How do they make money?
Venture capitalists invest money in startups with the hope of selling them in a few years' time at a subtantial profit (reaping many times the initial investment), either to another VC fund, to another company, or via an IPO. Venture capitalists add value to the companies they buy not only by giving them access to cash, but also by providing them with specific expertise and giving them access to their large networks and contacts in the industry.
How is Venture Capital different from Private Equity?
Private equity firms invest in stable companies using a lot of debt, and typically want a majority or controlling stake. Private equity aims for a two to three times return on their initial investment. Venture capital firms invest in high growth companies using no debt and are usually happy with a minority stake. Venture capital aims for a five to ten-plus times return on their initial investment.
What kind of companies do they buy?
Venture captialists invest in companies across all sectors, but most commonly in high growth areas in technology, internet or healthcare. Required features are:
- Very strong growth. Think how companies such as Google, Twitter, Facebook took on the world in a few years. Therefore, venture capitalists are looking for the next big idea and want to see at a very minimum double digit revenue growth, and ideally over 30%+ growth per annum
- Large markets. Some companies may be growing fast but if they are in a small niche, they will quickly mature and be less attractive investments. The best companies for venture capitalists are those that can address many products, many geographies and target many people.
- Scalability. Companies that can easily expand at a low cost are attractive. Again, companies like Google and Facebook are great examples because they can reach very large audiences at a very low costs. The same applies to software companies, or even medical companies: once the product is created, it is cheap to sell it globally.
- Great management teams. Venture capitalists will always look for smart and very ambitious management that will be able to work very hard to make the company succeed.
What about job prospects and salaries?
Venture Capital firms are usually quite small, so there are few jobs available and this makes the industry extremely competitive. Salaries tend to be lower than what you would find in private equity or investment banking, because the funds managed are smaller and most of the remuneration comes from a share of the returns of the investments. This share of investments, if the fund performs well, can be very substantial. What kind of people work in Venture Capital Venture Capital funds tend to hire people that have science backgrounds (technology, biology, healthcare, etc.) and also often hire entrepreneurs and people that have experience working in startups. However, there is a large number of ex bankers and ex management consultants at the larger firms that were focused on Technology, Media or Healthcare sectors. Can you give me a list of VC funds in Europe? You can check our list of European VC funds