External sources of finance come from outside the business. Venture Capital (VC) belongs to external sources of finance. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance.
The amount of long-term finance needed for buying Fixed Assets, or Non-Current Assets, with a relatively low value such as vehicles will be small. While the amount of long-term finance needed for buying Fixed Assets, or Non-Current Assets, with a relatively high value such as new machinery for the assembly line will be large.
3. Venture Capital (VC)
Venture Capital (VC) is capital invested in business start-ups or growing small and medium businesses offering innovative technology. These companies have high market growth potential along with extraordinary profitability, But, at the same time have high risk of failure.
As traditional lenders are usually not very willing to invest in risky new technology, these businesses find it difficult to raise finance for their groundbreaking high-tech products. This is because of many risks to the business.
Hence, specialized Venture Capital (VC) firms, long-term investment funds and wealthy individuals take high risks of investing their capital in exchange for a large part of the business. They will take those risks, but only for acquiring a sizeable number of shares.
Venture Capitalists (VCs) will usually ask for between 30% to 70% ownership of the business. They will also expect a share of the future profits in return for their investment. In exchange, they will not only provide the business with that much needed cash, but also with invaluable advice about strategic business growth.
Example 1: Sequoia is an example of a Venture Capital (VC) firm specializing in incubation, seed, start-up, early, growth, emerging growth, mature, mid-venture, late-venture and PIPE investments in private and public companies. Sequoia seeks to invest specifically in the fintech sector, but also focuses on investing in other sectors: energy, financial, healthcare, Internet, mobile, outsourcing and technology.
Who can make Venture Capitalists (VCs) interested in their new business?
Private equity firms, or small companies not listed on the stock exchange, which offer innovative goods and services, have the highest chance of raising capital from Venture Capitalists (VCs).
These firms must be able to grow fast and scale fast. Ultimately, these privately-owned businesses will convert into a public limited company in the few years making the investors very rich.
The applications must be able to present a business plan with supporting financial data to prove that the high risks really are worth taking.
What are Venture Capitalists (VCs) interested in the most?
Venture Capitalists (VCs) will look at a number of factors before committing any of their money into a new investment project.
- The business plan. The product idea must be innovative and unique. The business must have the ability to compete in a high-growth market with strong competitors. The long-term business aim of the new business venture should be clear and meaningful. Only in this way, the investors can feel confident that the business fully understands the market in which it operates and the direction it wants to develop in the future.
- Track record. The investors will obviously assess the past performance of the business to find out how well or how poorly managed the business is. Before investing any capital, they will conduct a thorough investigation to get detailed overview.
- Return on Investment (ROI). Investors will require a return from investment on their capital sooner or later. They will also expect the business to grow fast in terms of sales revenue and market share, and generate hefty profits.
- People. Venture Capitalists (VCs) will want to know who the managers of the business are, what skills, experiences and contacts they have to be successful. Ineffective people management is one of the major reasons why many new companies fail. Therefore, in the business world people are important.
Why Venture Capitalists (VCs) take the risk?
Venture Capitalists (VCs) take great risks, but rewards can be extraordinary.
If the new high-tech business is successful, Venture Capitalists (VCs) will gain significant returns from their investments sometimes ranging up to 10,000% or even 100,000%. This is because the value of certain high-tech businesses has the potential for rapid growth.
However, there is also a considerable chance of losing all the money in case of complete business failure.
Those risks could come from the company not being able to launch those highly-advanced technological products to the market, lack of demand or competition catching up too soon.
