How Does VC Work?

Venture capital is part of a well-known human interaction we all benefit from at some point. It's the dynamic of asking someone to help you reach your goals. Of course there’s much more to it than that, but that's the rub of it: You have something you want to do and need help to do it. VC simply focuses that relationship into financial assistance in the form of investment. But, how does it really work?

Investors tend to seek out the riskier end of the capital raising market – it tends to come with greater rewards when it works. VC aims for businesses that find it difficult to gather funds through the usual startup sources such as personal savings or family, or, for more serious financial targets, through banks and mainstream lending avenues.

Venture capital funds have a more flexible – but still rigorous – return schedule and are tuned into new ideas and less conservative. They understand the kind of creative sparks that tend to be lost on the local branch bank manager.

The reason is simple; VC funds are generally pooled resources of wealthy individuals who are looking to add to their wealth but also give something back to help others grow and reach the same lofty heights. As such, they may be prepared to take on more risk for the promise of greater, more diverse rewards. 

Don’t be fooled, the focus remains on firm returns and high profitability, often in burgeoning markets or niche areas. And we all have an exit strategy. VC investors will often look for a sizeable equity interest or seek steep interest for their expenditure in your dream.

A smaller number of backers – as opposed to millions of shareholders for banks – allows VC operators to limit themselves to specific industries or sectors. It means the experience and knowledge of their team can be laser-point focused. For this reason, and because of huge scalability leading to greater profits, IT and biotech startups are both popular destinations for VC funding.

While venture capital firms will generally focus on startups, they may also provide input for expansions too. In fact, VC investment tends to work in stages, from seed funding for the nascent concepts to mezzanine funding to bolster growth. The final stage is the exit or bridging stage, where VC investors will look to leave you alone to make your own way. Here, the venture may enter an IPO, at which point investors are hoping for their big payout as they sell their equity stake.

So, where's it all heading? Well, the old days of the world’s IT startups gathering in Silicon Valley like geeks at a Star Trek convention are coming to a close. Today, VC is more entrenched, dispersed and common – and its impact is as valuable as ever. The latest federal budget in Australia has cut funding for Co-operative Research Centres and for a range of other government-funded startup initiatives, increasing the startup scene’s dependence on private VC relationships. Venture capital is an advocate of startup success, and it’s here to stay.

If you're an entrepreneur, it makes sense to know how venture capital works. If you’re smart, it pays to take advantage of it.