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Venture Capital: What it is and How it works

Rent, stock, wages, furniture, bills, equipment, supplies. With what feels like an endless list of outgoings, the basics of business sometimes don’t leave much budget for growth. This is why some businesses turn to venture capital as a way to access the funding they need to fulfil the enterprise’s true potential.

But what is venture capital? And how do you get your hands on it?

Despite being a popular method for raising money, venture capital (VC) can seem like a daunting topic. But we’re going to break it down, little by little. Read on to find out how it works, the process for getting it, and whether it could be right for you.

What is venture capital?

At its most basic, venture capital is a business investment made in exchange for equity. By selling equity to investors, the owner gives up part of the ownership of their business, along with some voting rights and a slice of the profits and losses.

Venture capital will typically come from a venture capital firm, who tend to look for emerging businesses that are showing a lot of promise. For them, it’s a game of high risk – but with it brings the chance of higher rewards. VCs invest in new or fast–growing companies in the hope that they can earn a return when the company (which they now own a part of) grows and turns into a success.

This is the ideal scenario, but a happy ending is never guaranteed – and many VC firms will experience high rates of failure, due to the challenges and uncertainties that all new businesses face. But, when it does work, both the VCs and business owners can reap the rewards.

How does venture capital work?

Venture capital firms gather money from various different sources, such as companies, pension funds and wealthy individuals, and put it all into a fund. With that fund, they can invest in different businesses.

In most cases, the investors will know how their money is being used, as well as all the expected risks and rewards that come with that investment.

Once a VC finds a business they’d like to invest in – and have gone through all the necessary checks and due diligence – they’ll then negotiate how much to invest and for how much equity. The funds will then be released to the business all at once or, more commonly, in rounds. In some cases the VC firm will take an active role in the management and growth of the company.

There are lots of ways VCs can get their money back – whether it's by the shareholders of the company buying them out, another business buying the company they've invested in, or even going public and floating on the stock exchange. No matter what the exit strategy is, VCs usually try to make good on their investment in between 3 and 7 years.

By Iwoca