Have you ever watched “Shark Tank” on television? The entrepreneur, sometimes knowledgeable other times not, is trying to persuade venture capitalists to invest in their emerging business. They are pleading for monetary help to expand their business or market a product. Even with this type of publicity, the world of the venture capitalist can be confusing. There are some questions which are asked over and over. Here are a few of the frequently asked questions about venture capital.
What kinds of companies does a venture capitalist typically invest in?
Most of the time venture capital firms such as Effi Enterprises invest in young, private businesses that have a huge potential for growth. Venture capitalists have been a very important part of helping to develop the computer and technology industries. Although there have been some recent expansion on the part of venture capitalists outside the norm, they typically invest in high technology companies. A venture capital firm can offer business funding that is needed for expansion or redevelopment once it is well established.
What makes a Venture Capitalist different from other types of investors?
When a venture capitalist invests in a business it is not simply with the hope that they will earn “interest” on their money. They want to earn a substantial profit which means that they believe the company is going to do very well. They are a long term investor and will not even expect a return for at least 7 to 10 years. When they make their initial investment it is actually the start of a long term relationship with the business. This means that they will also be offering managerial assistance when needed. They will help the business build a strong team and learn how to manage rapid growth. They usually do this in exchange for some of the stock of the company.
Is there a difference between venture capital and private equity?
Yes, there is. Venture capital is more of a subset of private equity. The asset class we call private equity includes several investment options including venture capital, mezzanine investments and buyouts. Venture Capital centers on investments made in young but fast growing companies. Other types of private equity will focus primarily on investing in larger, more mature companies. Venture capitalists offer cash investments in exchange for equity. They do not use buyouts as part of their strategies.
Does venture capital have any influence on a region’s economy?
The venture capitalist firm will invest money directly into a business and this will boost the local economy in the way of payroll, fees paid to accountants, lawyers and other professionals who are needed to support the firm. VC firms also pay state taxes on the capital gains that they generate. These types of investments are to help expand a company which in turn will create more available jobs. In the way of averages, about 75% of VC investments are used for payroll. Every $1 million of VC investments directly sustains or creates 7.5 skilled or higher paying positions. For each higher leveled job created, there are another 2.2 lower level jobs created. Over a period of time, a company which is financed through VC will typically grow to be one of the major employers in the region.
Beyond creating and sustaining jobs, VC will help increase sells, exports and R&D; as well as generate a tax income for the area and the local government. For each $1000 of VC funding the company should have about two times the sales and pay about three times the federal taxes, generate nearly double the exports, and invest nearly three times more in R&D as the company which is not backed by VC funding.