Venture capital operations are a form of financing that involves the contribution of capital to early-stage or early-development companies with high growth potential and elevated levels of risk, in exchange for a percentage of the company shares.
This article provides a basic guide to understanding how venture capital investments work, their purpose, and how they can be carried out. It also explains the different types and characteristics of venture capital investments.
What is the objective of this type of investment?
Investing in venture capital (VC) aims to increase the value of the company as quickly as possible. This approach seeks to achieve the highest possible profits on the investment at the end of the agreed period.
This is done by injecting capital into the company to facilitate rapid growth and market consolidation, thereby increasing the value of its equity.
In which VC projects can one invest?
Depending on the stage of the project or company receiving the capital, four types of investments can be distinguished:
(i) Seed capital: Prototypes of companies that have not started economic activities or even formulated a business plan yet.
(ii) Spin-out: Companies derived from academic institutions, universities, etc., aiming to leverage the resources of the original organization for new business opportunities.
(iii) Start-up: Newly established companies with viable projects.
(iv) Early/Late stage: Recently established companies with viability but at a more advanced stage than start-ups.
How to invest in VC? Equity investment vs.convertible loan
The decision to bring in investors is made by the VC company, and it can choose between two alternatives: receiving direct equity investment or providing convertible loans.
For the investor, both instruments offer the opportunity to generate profits, but they represent different ways of financing:
Equity investment is often more attractive to investors as it allows them to receive compensation in the form of shares of the company without waiting for a future and uncertain moment.
On the other hand, convertible loans are less complex for the target company, allowing them to delay the introduction of new partners into the company, and letting the entrepreneurs to keep control of their company at the initial phase. However, the disadvantage in these cases is the existence of a debt that must be paid to the investor within a specified period of time.
What types of company valuation exist?
When identifying a target company for VC investment, different types of discounts or valuations can be considered:
Types of investors
When a person decides to invest in VC, they can choose between different business models: business angels, venture capital funds, risk capital funds, and financing through family or trusted individuals.
If you want to learn more about this type of investment, Gentile Law can help you understand it and provide guidance.