What is Venture Capitalism and How Does it Work?


Business / Friday, November 1st, 2019

 

These days it seems like almost everyone is looking for a way to supplement their income. Whether they’re contract drivers in the evenings and on weekends or they run their own Etsy store, it is said that approximately 43% of all Americans have some sort of side job. There’s another way to earn extra money, though, that doesn’t require working any extra hours. Some people are turning towards investment as a way to earn extra money, and there is one type, in particular, is gaining in popularity.

What is Venture Capitalism?

In the simplest of explanations, it is a type of loan. To be a little more specific, it’s a niche practice of investing. Individuals, groups, or businesses will invest their own money into a new and promising business that demonstrates high growth potential, and in return, they hope to receive a substantial return on investment. Again, this is a simple definition. As one might imagine, there are many nuances to this type of financing.

Who are the Investors?

It is possible to find individual investors, but it’s rare. Most investors are part of a public or private firm that is represented by a non-affiliated private entity. The investors themselves have money or other types of financial assets, which are generally pooled together from a variety of different individuals or businesses. Individuals typically rely on professional firms to manage their business portfolio.

There are some instances in which investors are sought out for their background, skills, or expertise – and not necessarily for their wealth. Microsoft, for example, sought out a man named Dave Marquardt because he was a well-known business advisor and strategic thinker. Although Microsoft didn’t need another financial investor at the time, they brought Mr. Marquardt on because they wanted his business insights. He was Microsoft’s only venture capitalist and ended up serving on their board of directors for over 30 years. Another example of an individual venture capitalist is Mark Stevens. Mr. Stevens was a partner at an investment firm and decided to invest in companies that showed incredible potential. These companies included Google, LinkedIn, and PayPal, all of which proved to become incredibly successful and financially solvent. Today Mr. Stevens owns a portion of the NBA basketball team, the Golden State Warriors, and is said to be worth approximately $2.6 billion.

How Does it Work?

In order to get enough monetary assets to work with, firms will collect money from a variety of different sources. In addition to working with wealthy individuals, they will also access money through bank or insurance company loans, and they will also encourage people to access their retirement accounts in order to increase its growth potential in a shorter amount of time. Once a substantial amount of money has been collected, firms will package it together and offer it to the company – who, in turn, will use it to expand their business, build new facilities, create new products, or attain more customers. However the companies choose to use the funds it must increase revenue potential. Experienced investors these days generally expect to see a profit of at least 25 percent.

What Kind of Business Get Venture Capital Funding?

As one might imagine, firms have incredibly strict criteria for which businesses they will support. In fact, most businesses won’t even qualify. Restaurants and small retail shops may not be appealing to investors. Firms are looking for businesses that can grow exponentially and one day become public. Unless a business has the potential to make an incredibly large profit, they’re generally not viable candidates for venture capital funding.

How Long Does it Take to Earn Money?

When you think about retirement accounts or Roth IRAs, you generally think of a life-long financial commitment. Venture capital investments last nowhere near that long, but they do average approximately five to eight years. Businesses take a while to get to the point where they’re turning a significant profit and possibly either go public or get bought out.

Risks

Although most investors are very careful to only put their money towards businesses that show impressive potential for turning a sizable profit, there’s always a risk when investing in a business. There will always be a degree of uncertainty when it comes to business needs, trends, and an ever-evolving market. If a business isn’t successful there’s always a risk that you might lose your money. Even though investors are commonly seen as silent partners, there’s always a chance that the people who loan you money will want to have a say in big business decisions…especially if part of the transaction includes a spot at the board member’s table. Again, some investors are sought after for their business expertise, but if they give unsound advice it could potentially result in financial loss.

The main caveat to venture capitalism is that you need to have money in order to earn more of it. However, if you have extra financial resources this could be a great investment option for you.

 

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