Venture Capital

Definition and Meaning of Venture Capital

Venture Capital is the financial capital which is provided by investors to high potential and high risk start-up firms and small companies with long term growth potential. The process by which the venture capital fund makes money is by owning equity in the company in which it invests which usually have a business model in high technology industries. For smaller companies that do not have admission to capital markets, this is a very important source of funding. This type of funding typically brings high risk for the investor, but at the same time it has also the potential for above-average returns.

Venture capital also includes technical and managerial expertise. It is also associated with job creation and as a measure of innovation within an economic sector. A majority of the venture capital comes from prosperous investors, economic establishments and investment banks. In fact, this form of raising capital is very much popular among those companies which are relatively new and have limited operating history and which cannot increase funds by issuing debts.

Venture Capitalists

A Venture capitalist is a person who makes venture investments, and they are expected to bring technical and managerial expertise as well as capital to the investments. A venture capitalist has the ability to identify those technologies which have the potential to generate high returns at the early stage. They also take the obligation in managing the entrepreneurial companies at the initial stage. In this way, they add skills as well as capital and hence realize a higher rate of returns.

Basic Venture Capital Formula

Venture capitalist always wants to achieve a certain Internal rate of return(IRR) He harvest his investment after a certain number of years when the project begins to pay off. After a specific time, the project will have a definite Price earnings ratio (PER). The percentage of the project that the venture capitalist must obtain is calculated by the following formula:

Final ownership required= {required future value} over {total terminal value} = {(1+IRR) ^ {years} *investment} over {PER*terminal net income}

The project share that the venture capitalist has to acquire to obtain 50% IRR is:

Final Ownership Required = { (1+0.5) ^ 5 * 3.5 mio } over {15 * 2.5 mio} = 70.9%