How Does Venture Capital Work?

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Venture capital, as we know, contributes to the formation of startup companies. It’s thanks to venture capital—in addition to other funds, of course—that these startups move into the innovation life cycle, otherwise known as the period when a company starts to commercialize their product or idea. They play an important role for entrepreneurs, to be sure, but the actual details of what venture capital does might be a little bit of a mystery.

 

So how does venture capital work, exactly, and why is it so crucial to an entrepreneur looking to grow their startup, other than because it’s part of their seed money?

 

How Venture Capital Firms Make Money

It might seem like all venture capital firms do is invest money in other companies. Not the case. Venture capital firms provide management to the companies they are helping structure, which in turn brings in a management fee. The other part of their income is the carried interest. Venture capital firms invest in private companies. In turn, the venture capital firms receive partial ownership in the business.

 

The whole process to receive funding from a venture capital firm takes approximately six months, give or take, beginning with an introduction and slowly becoming more involved as trust is earned and a relationship established.

 

Why Venture Capital Helps

Venture capital funding isn’t the end-all, be-all when it comes to whether or not a startup will be a success, and nor should it be. But, it helps because it can still be a good indicator of potential, according to Sahil Khosla, and when spent appropriately, can move a startup effectively from one phase to another.

 

With the right venture capital firm, a startup gains stability and more opportunities for growth, be in the form of potential future partners or perhaps an enlarged network of colleagues.

 

How Venture Capital Differs From Other Investments

It’s fair to wonder how venture capital is a different form of investment than say, private equity. After all, the two hold enough similarities that they appear alike. However, unlike private equity, venture capital firms will work with the industry rather than the specific company. Private equities invest in more established companies, but venture capital firms will invest in a new company in a strong industry. What’s more is, venture capital firms are involved in the operational structure of a company. They’re present from the beginning stages until the company is liquidated, acquired, or expands.

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