Venture Capital 101

What is Venture Capital?

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Venture Capital (VC) is a type of investment where individuals or firms provide funding to emerging startups for equity in the company. Normally, less than 50% equity will be given out. These startups send business plans to VC Firms and these firms will determine whether the business has potential or not. The VC Firm will perform due diligence, a detailed examination of a business’s records that analyzes and mitigates the risk from an investment decision. Once invested, the company is part of the firm’s portfolio, and it often receives assistance from the VC firm and access to a network of partners and experts.

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How was Venture Capital started?

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The earliest forms of venture capital took place in the 18th and 19th centuries when wealthy individuals funded risky expeditions and new inventions for a share of the profits. A prominent example is the whaling expeditions in the 19th century, where whaling was financed by investors, who would receive a portion of each catch. However, the first formal venture capital firm was the  American Research and Development Corporation (ARDC), founded by Georges Doriot, a professor at Harvard Business School. ARDC focused its funding on small, high-risk startups, believing they could drive innovation and economic growth. ARDC’s most prominent investment was in Digital Equipment Corporation (DEC). DEC became a major player in the computer industry and yielded massive returns, showing the potential of venture capital. As the late 1900s and early 2000s approached, venture capital experienced significant growth and transformation. During the dot-com boom, venture capital was brought to the forefront as all the new, fresh innovations, such as Amazon and Google, needed capital.

 

Stages of Venture Capital Investment

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Venture capital investment progresses through six key stages. 

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1. Pre-Seed Stage: In the Pre-Seed Stage, initial funding helps develop ideas and prototypes. This stage is the riskiest as startups are in their earliest phase with unproven ideas. 

2. Seed Stage: The Seed Stage is slightly less risky. Seed-stage funding is given to startups that are past the Pre-Seed stage or already have an idea. The Seed stage’s focus is to create a Minimum Viable Product (MVP) and gain early traction. 

3. Series A: Series A is the next stage with even less risk. Series A funding is given to companies that have already gained traction and whose long-term business model is starting to take shape. 

4. Series B: Series B is the last stage of early-stage venture capital. Series B funding is primarily given to companies to continue scaling after they have started generating revenue. For example, funding could be used to expand production, hire employees, or improve marketing efforts.

5. Series C and Beyond (Series D, Series E) funding is given to companies that are out of the start-up category and are running successfully. Series C and Beyond funding is used to significantly expand operations. For example, funding could be used to expand internationally or add a whole new division in the workforce.

6. Exit: The Exit Stage is the last stage of the venture capital investment process. In this stage, investors can gain back the money they invested (plus any profits) by selling their ownership stake in the company. Here are some ways that this can happen:

   1. Initial Public Offering (IPO): The company goes public and shares of the company are accessible to anyone. Investors can sell their shares at the IPO price or later in the public market. 

   2. Acquisition: A larger and more established company buys the startup. The investors are paid for their shares, usually at a price agreed upon in the acquisition deal. This payment can include cash, stock in the acquiring company, or a combination of both

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The Future of Venture Capital

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With the rise of Artificial Intelligence, jobs and industries as a whole are adapting and changing. Venture capital is no different, and with the implementation of AI, the industry could change forever. Though it’s difficult to predict the outcome of the implementation of AI in venture capital, it is evident that the industry will be reshaped. Due diligence and company evaluation could be automated, saving humans so much time, but this data-driven decision-making also has its flaws. Data-driven decision-making could cause AI to look past qualities that make startups what they are, human qualities such as leadership and teamwork that also are key indicators in determining the success of a startup. It is likely human decision-making will remain essential to uphold ethical practices and that subjective factors, such as leadership qualities and company culture, are properly evaluated, which AI may not fully capture.