It’s no question that venture capital often plays an important role in the support of new start-ups. Many aspiring company owners would still be concocting their business plans in their basement if it weren’t for the deep pockets of venture capitalists. This especially rings true in the tech industry.
The specific types of support that venture capitalists offer to small businesses varies but the general role they play is typically the same; they offer startups a shot at success that they otherwise wouldn’t have.
Having said that, venture capital funds aren’t always enough to ensure a new business will succeed. In fact, we know that most startups will fail, so what does the investor require from the aspiring business owner in return for their support? Let’s review the role of venture capitalists, and then dive into how companies that raise venture capital can have huge shifts in their stock prices.
The Role of the Venture Capitalist
A venture capital firm provides funding to small startup companies that they believe have the potential to succeed. So, why doesn’t a small business owner simply go to a local bank or financial institution for a loan? First, more often than not, the startup won’t qualify for a loan because they aren’t able to prove their ability to make sales. Without some sort of guarantee that their new business will work, the banks won’t take the chance of loaning out big money (or any money, for that matter).
Second, the role of a venture capitalist often goes beyond a financial investment. They can offer advice and guidance in a variety of business matters, and even offer other resources such as office space or a production facility. Most venture capitalists thoroughly research the startup that they’re funding, so they’re familiar with the industry and can offer sufficient support in a variety of areas.
So, what’s in it for the venture capitalist? Aside from potentially making their money back, oftentimes, the investment firm will require a steep repayment plan that includes stock ownership. It’s also common for venture capitalists to dictate the company’s board of directors, or at a minimum, take a seat for themselves.
Although it may not be ideal for the owner of a startup to fork over a decent percentage of their business, they often don’t have any other choice. Besides, if the company succeeds, everyone will profit.
Does Venture Capital Influence the Stock Market?
There are typically two common ways that venture capitalists can try to get their money back out of an investment. First, they can liquidate their stock positions by way of a merger or acquisitions of the business. Second, they can offer an IPO, or initial public offering.
To reiterate, at the end of the day, it’s the goal of both the venture capitalist and the business owner to make money and ensure the business succeeds. The best-case scenario for a venture capitalist is for the business to take off, potentially have a public offering of the stock, and cash in.
An example of this was when venture capital investment firms Bessemer Venture Partners and Sequoia Capital, provided funding for the then-startup company LinkedIn. Initially the shares were approximately $11.47 per share. Today, those shares hover around $43 a piece.
Hercules Technology Growth Capital is another venture capital investment company that has invested money into several startups. In fact, they’ve provided more than 170 companies with $2.4 billion in capital. So far, they’ve had 37 exit events which include taking seven of the companies’ stock public. Only time will tell the full effect this will have on each businesses’ stock prices.
What Business Owners Need to Consider
For the business owner, there are many important factors to keep in mind before signing on the dotted line with a venture capitalist. I recommended asking several of the following questions before you’re handing over 40% of your startup company…
- Are you clear about their goals for your business? Specifically, what are the goals for the investment they’re offering you?
- Are you open to the idea of an IPO or merger with another company?
- Do you fully understand the repayment process they’ve outlined?
- Have you considered their requirements in terms of your board of directors?
- If you want to continue running your business and retaining control, are they on board and supporting you in that capacity?
Today, it may feel near impossible to secure venture capital for your business. However, its vital to fully understand the commitment you’re making on behalf of your business before making any concrete decisions and accepting funding. If you’re not totally in align with the venture capitalists, the funding may not be worth the price you’ll end up paying in the long run.
Understanding How Venture Capital Influences the Stock Market
Venture capital can often play a pivotal part in the story of a small startup. Depending on the specific investors’ deal, they may opt to take a company public which could have huge implications on its stock value. Additionally, they could choose to merge with another company or work out an acquisition where the startup is absorbed by a giant in their industry. Ultimately, venture capital can help dictate the success or the demise of a business and its stock.
Learn more about my thoughts and predictions on venture capital this year, the state of the stock market related to the technology field, and much more at Money Morning.