Finance for Non-Financial Managers and Small Business Owners

By Lawrence W. Tuller | Go to book overview

Chapter 12
Venture Capital

VENTURE CAPITAL, also known as risk capital, is the primary source of financing for start-up businesses, R&D ventures, and companies bringing out new product lines. Selling equity shares directly to venture investors avoids the costly exercise of using underwriters when making a public stock offering. It also gets cash into your company much faster than the convoluted process of going through an initial public offering (IPO). However, not all firms can attract risk capital. Venture investors expect to make high returns on their investment, and this can happen only through an initial public offering in the future—usually within five to seven years.

The underlying assumption made by venture capital investors is that as a company’s products are accepted in the marketplace, sufficient investor interest will be generated to make an IPO feasible. The resultant trading market should then enable the original investors to cash in their chips and realize a substantial appreciation on their investment. In the right situation, they may hang around for a while to see whether the market will drive the share price up, but only when the spread between the offering price and the expected gain is fairly wide.

In most cases, venture capital investors want to monitor their investment by taking seats on your board of directors. In other cases, fearing the potential liability that goes with board membership, they will choose to be board advisors. Either way, they usually, but not always, insist on the controlling vote. At the same time, most venture investors recognize that, if and when a company needs additional 209

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