Understanding How Venture Capital Works

Sixty years ago, the Small Business Investment Act of 1958 was passed, paving the way for the venture capital industry.  The act enabled the U.S. Small Business Administration (SBA) to provide licenses to private small business investment companies (SBIC) to finance, operate, and manage start-up businesses in the country.


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Not long after, a technological startup called the Fairchild Semiconductor, which is known as the first to manufacture and commercially distribute practical integrated circuits, became the first company to be funded by a venture capital investment firm.


Since then, venture capital firms or investors have helped many startup companies and emerging small businesses with long-term growth potential but have no access to capital markets.  Venture capitalists add value to a company through financing and by taking an active role in the company’s decision-making.


Businesses seeking venture capital funding can create and submit a business plan to firms and investors.Because of the risks involved in such a partnership, interested venture capitalists then practice due diligence, which includes a thorough investigation of the business’s management, operations, products, services, and more.


If the venture capitalist decides to go through with the partnership, an investment in the company is made in exchange for some of its equity.  Usually, capital is given in “rounds,” with funds transferred to the company only if it has met previously-agreed milestones.


Image source: hec.edu

The investor then exits the company after a period of time, usually four to six years on average.The exit is done through mergers, acquisitions, or initial public offerings (IPO).


Gregory Lindae is an investment industry expert focusing on venture capital and private equity markets.  He has worked for prestigious financial companies, such as BlackRock, Salomon Brothers, and FMO.  Learn more about the financial industry by visiting this website.

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