Capital Works Seeks to Explain the Venture

¶ … Capital Works seeks to explain the venture capital industry, debunk myths and offer a view of what the role of venture capital is to the U.S. economy. Zider begins by explaining that venture capital does not provide as much money to start-ups as is often considered to be the case. In general, venture capital goes to follow-on funding for projects that were originally developed by governments or corporations.

Those latter bodies perform the innovation task, and venture capital comes in once the product/service has been developed somewhat and needs to be taken to market. Because of this, venture capital is short-term money, not long-term. The objective of the venture capitalist is to commercialize an idea and then exit either by taking the company public or selling to a larger company. Venture capitalists exist, Zider points out, because this segment of the capital markets is underserved by other players. In that vacuum the venture capital business has arisen.

It is important that firms who are in such industries seek venture capital at the right time, after the startup phase and before the maturity stage when growth begins to slow. Venture capital investors tend to be large institutional investors, for example pension funds, insurance companies and financial firms. For these investors, venture capital is a small part of the total investment portfolio and is generally considered to be among the riskier parts of the portfolio.

They typically only invest in projects that are somewhat proven (in order to mitigate risk) and that have a high rate of expected return. The author debunks the myth that venture capitalists invest in people and ideas; rather, they tend to invest in good industries. The idea is that if a market has untapped demand, a good company entering that market can grow fairly quickly, and with a relatively low degree of risk. The author points out some of the things that venture capitalists look for in a deal.

They want some downside protection, such as preferred shares to give them preference in the event of liquidation. They also often want a fairly high degree of control over key decisions. This can include the timing of the IPO (as this is often a key component of the VC's exit strategy), the ability to invest more and protections against dilution. At times, VCs will want to put their own management teams into place to help with the commercialization of the business.

In many situations, a company will get financing from multiple VCs at once, a lead investor and follower investors, with the former having better rights, protections and controls. Because venture capitalists are seeking returns, they want very high rates of return, from which they pay out their investors and then keep whatever upside is left. This cut of the appreciating asset is probably the most important source of income for the venture capitalists.

VCs also like relatively low maintenance projects, since they can work on around ten different companies at a given time, in.