investments in a project

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26 Jan 2013

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Venture Capital is a form of "risk capital". In other words, capital that is invested in a project (in
this case - a business) where there is a substantial element of risk relating to the future creation of
profits and cash flows. Risk capital is invested as shares (equity) rather than as a loan and the
investor requires a higher"rate of return" to compensate him for his risk.
The main sources of venture capital in the UK are venture capital firms and "business angels" -
private investors. Separate Tutor2u revision notes cover the operation of business angels. In
these notes, we principally focus on venture capital firms. However, it should be pointed out the
attributes that both venture capital firms and business angels look for in potential investments are
often very similar.
What is venture capital?
Venture capital provides long-term, committed share capital, to help unquoted companies grow
and succeed. If an entrepreneur is looking to start-up, expand, buy-into a business, buy-out a
business in which he works, turnaround or revitalise a company, venture capital could help do
this. Obtaining venture capital is substantially different from raising debt or a loan from a lender.
Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of the
success or failure of a business . Venture capital is invested in exchange for an equity stake in the
business. As a shareholder, the venture capitalist's return is dependent on the growth and
profitability of the business. This return is generally earned when the venture capitalist "exits" by
selling its shareholding when the business is sold to another owner.
Venture capital in the UK originated in the late 18th century, when entrepreneurs found wealthy
individuals to back their projects on an ad hoc basis. This informal method of financing became
an industry in the late 1970s and early 1980s when a number of venture capital firms were
founded. There are now over 100 active venture capital firms in the UK, which provide several
billion pounds each year to unquoted companies mostly located in the UK.
What kind of businesses are attractive to venture capitalists?
Venture capitalist prefer to invest in "entrepreneurial businesses". This does not necessarily mean
small or new businesses. Rather, it is more about the investment's aspirations and potential for
growth, rather than by current size. Such businesses are aiming to grow rapidly to a significant
size. As a rule of thumb, unless a business can offer the prospect of significant turnover growth
within five years, it is unlikely to be of interest to a venture capital firm. Venture capital
investors are only interested in companies with high growth prospects, which are managed by
experienced and ambitious teams who are capable of turning their business plan into reality.
For how long do venture capitalists invest in a business?
Venture capital firms usually look to retain their investment for between three and seven years or
more. The term of the investment is often linked to the growth profile of the business.
Investments in more mature businesses, where the business performance can be improved
quicker and easier, are often sold sooner than investments in early-stage or technology
companies where it takes time to develop the business model.
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