Whether you’re catching an Uber
, booking an Airbnb
or buying a pair of Allbirds
, you use services and products from venture capital-backed companies every day. Yet, the average person is unlikely to know much, if anything, about this world.
Which makes sense—it’s a complex topic. But, even though the industry is always changing, the fundamentals of venture capital have stayed the same.
In this article, we break down the basics and explain what you need to know.
What is venture capital?
Venture capital is a major subset of a much larger, complex part of the financial landscape known as the private markets. Venture capital is a form of financing, where capital is invested into a company, usually a startup or small business, in exchange for equity in the company.
What is a venture capital firm?
Venture capital firms fund and mentor startups or other young, often tech-focused companies using capital raised from limited partners
. Examples of venture capital firms include:
The venture capital firm has invested in companies like Uber
The venture capital firm has invested in companies like Lime
What is a venture capitalist?
Investors working at a venture capital firm are called venture capitalists.
Not to be confused with an angel investor, which is a wealthy individual who invests their own money into promising companies, a venture capitalist raises and invests capital from limited partners. Mark Cuban and Lori Greiner, frequent investors on ABC’s Shark Tank, are examples of angel investors.
In 2017, there were 4,589 active VC investors. To put that into perspective—since 2007, the number of investors in the industry has increased 163 percent.
How venture capital works
To raise the money needed to invest in companies, venture capital firms open a fund and ask for commitments from limited partners. This process allows them to form a pool of money, which is then invested into promising private companies. The investments they make are typically in exchange for minority equity—which is a 50 percent or less stake in the company.
As companies grow, they go through the different stages of venture capital. Additionally, firms or investors may focus specifically on certain stages—which impacts how they invest.
When a venture capitalist provides an early-stage company with a relatively small about of capital to be used for product development, market research or business plan development, it’s called a seed round. As its name suggests, a seed round is often the company’s first official round of funding. Seed round investors are typically given convertible notes, equity or preferred stock options in exchange for their investment.
The early stage of venture capital funding is intended for companies in the development phase. This stage of financing is usually larger in sum than the seed stage because new businesses need more capital to start operations once they have a viable product or service. Venture capital is invested in rounds, or series, designated by letters: Series A, Series B, Series C and so on.
The later stage of venture capital funding is for more mature companies that may or may not be profitable yet, but have proven growth and are generating revenue. Like the early stage, each round or series is designated by a letter.
If a company a VC firm has invested in is successfully acquired or goes public, the firm makes a profit and distributes returns to the limited partners that invested in its fund. The firm could also make a profit by selling some of its shares to another investor in what’s called the secondary market.
What is corporate venture capital?
Within venture capital, there is a subset called corporate venture capital (CVC). A corporate venture capital firm makes investments on behalf of large companies that strategically invest in startups—often those operating within or adjacent to their core industry—to gain a competitive advantage or increase revenue. Unlike VC investments, CVC investments are made using corporate dollars, not through capital from limited partners.
Examples of corporate venture capital firms include:
As the corporate venture arm of Alphabet, Google’s parent company, the firm seeks to invest in technology and media sectors. The firm has invested in companies like CryptoKitties
As the corporate venture arm of General Electric, the firm has made investments in companies like Carbon
, Sarcos Robotics
Interested in learning more about the private markets? Download our guide to understanding this fast-growing economic sector.