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What Is A Venture Capitalist? Types, Advantages, And Disadvantages!

Finance BY upasana Sep 09, 2023
What Is A Venture Capitalist Types, Advantages And Disadvantages!

A venture capitalist, or a VC, is a private equity investor who provides capital to those companies that have tremendous growth potential. However, a venture capitalist will provide the demanded capital in exchange for equity stakes.

A venture capitalist is very important in providing funds to start-up businesses or supporting small companies that look forward to expanding but have no proper access to the equity market.

If you are looking forward to knowing what is a venture capitalist and a lot more about this category of business, stay with us as we explore all of its features and benefits in depth.

Key Takeaways

In simple terms, a venture capitalist is an investor who allows capital to young companies while getting equity in return.

Most startups prefer going to a venture capitalist for funds to commercialize and scale their products.

A venture capitalist offers capital to companies that are yet to prove themselves; therefore, the rate of failure also remains high. You can read more about venture capital and how they work to help companies gain capital.

However, in the case of those investments which do turn out good, the winnings are quite substantial.

A few of the most popular venture capitalist investors are Jim Breyer, who was an early investor in Facebook, and Peter Fenton, who invested in X, which was formerly known as Twitter.

What Is A Venture Capitalist? Let Us Understand

What Is A Venture Capitalist_ Let Us Understand

Venture capitalist organizations are generally built as limited partnerships, where the partners invest in a venture capitalist fund. A committee is typically given the task of making the investment decisions.

Once the companies that have promising growth are identified, the collected investor capital is positioned to fund these companies in exchange for a substantial equity stake.

Compared to common belief, venture capitalists do not usually fund a startup at the time of its outset. Rather, a VC will seek to target those firms that bring in revenue and are looking for more funds to commercialize their idea.

The venture capitalist fund will be buying a stake in these organizations, cater to their growth, and seek to cash out with a substantial rate of return on investment.

Venture capitalists usually look for companies that have a strong management team, a large potential market, and a unique service or product with a solid competitive advantage.

They also look out for opportunities in industries that they are familiar with, along with the chance to own a big percentage of the organization so that they may influence the direction it goes.

Venture capitalists are always willing to take risks by investing in companies because they may earn a huge return on investment if the companies succeed. However, a VC will also face a higher rate of failures because of the companies’ uncertainty that comes with new companies that are yet to prove themselves.

Wealthy individuals, pension funds, insurance companies, foundations, and corporate pension funds may collect money in a fund that is controlled by a venture capitalist firm. The venture capitalist organization is the general partner, while all the other individuals or companies are limited partners.

All partners exercise part ownership over the fund. However, the venture capitalist firm controls all the areas where the money is getting invested. That is usually ventures or businesses that most of the capital markets or banks deliberately avoid because of the high degree of risk.

Managers of venture capital funds get management fees along with carried interest. Depending on the firm, a company pays roughly 20% of the total profits that manages the private equity funds. The rest of it goes to all the limited partners that have invested in the fund.

General partners are also due a 2% additional fee.

Types Of Venture Capitals

Venture capital can widely divide as per the growth stage of the company that receives the investment. In simple terms, the younger the company, the more risk it will pose for investors to invest in it.

The three types or stages of venture capital are:

Pre Seed

This is the initial stage of business development when the founders work on turning what was just a mere idea into a solid business plan. They may also enroll in a business accelerator to provide early mentorship and funding.

Seed Funding

This is the position where a business gets all prepared to launch its very first product. Since they do not have any revenue streams by then, the company will require a venture capitalist to fund all of its business operations.

Early Stage Funding

Once a business develops a product, it will need additional capital to boost production and sales before it can afford to fund itself. The business, in that case, will require one or more rounds of funds. That usually denotes as Series A, Series B, and so on.

Venture Capitalists: Advantages And Disadvantages

Venture Capitalists_ Advantages And Disadvantages

Venture capitalists offer funding to relatively newer businesses that do not have any access to the share markets. They do not have enough cash flow to take loans. This arrangement is mutually beneficial as businesses receive the capital that they need to start their business operations. The investors, in turn, get a portion of the equity in the promising companies.

There are other benefits as well of a venture capital investment. Venture capital provide funds to the new organizations. But, it also provides efficient mentoring services that help the companies establish themselves. Not only that, the VSs also help companies find fresh talent and good advisors. A company that has good backing from a venture capitalist may easily leverage itself into further investments.

In contrast, a business that accepts venture capitalists may lose its creative control over the decisions in the future. Venture capitalist investors demand big shares of the firm’s equity and start demanding the management of the company as well.

There are also multiple venture capitalist investors who are only looking to make a rapid and high-return payoff. For this, they may pressure the company to make a quick exit.

Why Is A Venture Capitalist Important?

Entrepreneurship and innovation are the key elements of a capitalist economy. Newer businesses, however, are mostly highly risky and cost-intensive innovations.

As a result, external capital mostly seeks to spread failure risks.

However, in return for taking risks in these investments investors in new companies gather equity in the company. Venture capital, therefore, is a great way for startups to get off the ground and business owners to achieve their vision.

The Bottom Line 

Venture capitalists are the representation of the central part of the lifecycle of any business. In this article, we have briefly discussed what is a venture capitalist, its types, advantages, and disadvantages.

Before an organization can start generating revenue, it requires enough capital to hire employees, design products, or even rent facilities.

Venture capitalists provide this fund in exchange for a portion of the new firm’s equity.

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Upasana is a budding journalist who has a keen interest in writing. She considers writing as therapeutic and is most confident when she writes. She is passionate about music, movies and fashion. She writes in a way that connects with the audience in a personal level. She is optimistic, fun loving and opinionated.

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