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Venture Capital

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Venture capital is the financial backing that a company receives before it goes public. There are a variety of reasons that a company may choose to use venture capital. The most prevalent reason is that the start-up is high risk. Most companies prefer to receive their funding from banks. A company uses venture capital when it is deemed too high-risk to be a good investment for a bank or other lending institution.

Venture capitalists are in high risk, high reward investment situations. The person, or persons, seeking funding from a venture capital firm must make a presentation to the firm and try to sell the venture capitalists on the company's business plan. One estimate shows that venture capitalists only back one out of every 400 proposals that is presented to them.

Not every company is suited to receiving venture capital funds. In order to stay afloat in the volatile market of business start-ups, venture capitalists choose investments that have a chance of a high rate of return in a short period of time. Most venture capital firms prefer to provide financing and be ready to receive their returns within three to seven years. Many companies that go on to be very successful just do not have the ability to grow that quickly.

Another factor in offering venture capital funds is the willingness of the company to work with the venture capital firm and take advice and direction from them. One of the more common expectations of venture capital firms is that they will place their own people in not only key management roles within the company, but also have at least one seat on the board of directors.

Types of Venture Capital
The first round of funding with venture capital is called seed funding. This is an early investment in the company that is used for market research, testing and additional business plan refinement. The second round of financing is called start-up capital. This is when staff is hired, equipment is purchased or rented, and the business actually opens its doors.

During the early stages of company's growth, it is not uncommon for additional financing to be needed. If the facilities need to be expanded or additional staff or equipment need to be brought in, the venture capital firm will often provide this funding as well. This is called development capital.

The last round of financing before a business goes public is called mezzanine financing. This final round prepares a company for an IPO or acquisition, which ends the venture capitalists' interest in the company. After a company goes public, any additional funding needs will be taken care of by issuing and selling stock.

At the end of the venture capitalists' interest in the company, they harvest, or sell their equity in the company. Equity may be in the form of stocks, options or other forms of paper, but once they sell, it concludes their involvement in the company, and they have their profit. This money is usually reinvested into another start-up in need of venture capital.

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