Venture capital (VC) is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth (in terms of number of employees, annual revenue, scale of operations, etc).

Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful. Because startups face high uncertainty, VC investments have high rates of failure. The start-ups are usually based on an innovative technology or business model and they are usually from the high technology industries, such as information technology (IT), clean technology or biotechnology.

A financing diagram illustrating how start-up companies are typically financed. First, the new firm seeks out “seed capital” and funding from “angel investors” and accelerators.

Then, if the firm can survive through the “valley of death”–the period where the firm is trying to develop on a “shoestring” budget–the firm can seek venture capital financing.The typical venture capital investment occurs after an initial “seed funding” round. The first round of institutional venture capital to fund growth is called the Series A round. Venture capitalists provide this financing in the interest of generating a return through an eventual “exit” event, such as the company selling shares to the public for the first time in an initial public offering (IPO), or disposal of shares happening via a merger, via a sale to another entity such as a financial buyer in the private equity secondary market or via a sale to a trading company such as a competitor. [Wikipedia]

What is venture capital?

Venture capital is a financing tool for companies and an investment vehicle for institutional investors and wealthy individuals. In other words, it’s a way for companies to receive money in the short term and for investors to grow wealth in the long term. VC firms raise capital from investors to create venture funds, which are used to buy equity in early- or late-stage companies, depending on the firm’s specialization (although some VCs are stage-agnostic).

These investments are locked in until a liquidity event, such as when the company is acquired or goes public, at which point VCs realize profits from their initial investment. Venture capital is characterized by high risk, but also high reward. On the one hand, VCs must invest in emerging technologies and products that have massive potential to scale, but aren’t profitable yet — and over two-thirds of VC-backed startups fail. At the same time, VC investments can prove to be enormously profitable, depending on how successful a portfolio startup is.

For example, in 2005, Accel Partners invested $12.7M in Facebook for a ~10% equity stake. The firm sold a part of its shares in 2010 for around half a billion dollars, and went on to make over $9B when the company went public in 2012. [cbinsights]