OVERVIEW OF VENTURE CAPITALISM Venture capital refers to the funding of a business enterprise. What distinguishes it from traditional business capital is that venture capital financing is often given to unproven, potentially profitable business models that present significantly more risk than funding wellestablished business enterprises. Although venture capital is not limited to the technological field, technology companies usually benefit from venture capital funding. This is because technology companies generally involve new and unproven technologies that traditional business financing sources are reluctant to fund. The possibility of high returns compensates for the high risk of funding startups and new technologies. The gain is usually through capital gains brought about by the success of the new technology or business model. Profit through capital gains is contrasted with profit through income or dividend yield.
Venture capitalists usually build a long-term relationship with the businesses they are funding because, beyond money, venture capitalists also serve as mentors for other areas of the business such as marketing, human resources, and management. Venture capitalists usually come in as copartners of the company founders. Venture capital initiatives have several common features.
One of these features is risk. Venture capital risks are of four kinds. The first is management risk. This is the risk that the enterprise's management team being funded fails to work as a team. This is especially true if the venture capitalist partners add new people to the existing company management as part of the funding deal and the new people have conflicting ideas with the founders. Even if management works like a well-oiled machine, company operations might be too expensive to turn a profit, or operational processes may prove faulty. This is known as operational risk, which is the second kind of risk.
When the product or service from the new enterprise finally hits the market, there are still two kinds of possible risks: market risk and product risk. Market risk is risk of the product or service failing because the target market rejects it. Product risk refers to introducing products or services that might not be commercially viable. Another feature of venture capitalist initiatives is the involvement of high technology. All venture capitalist enterprises do not share this feature, but high technology is common to most of them. The reason is that the involvement of high technology, contrasted with low technology, presents the possibility of the higher returns that venture capitalists are looking for to balance the risks.
All venture capitalist partnerships result in equity participation, leading to capital gains. Founders of businesses that look for injections of venture capital funds must be ready to share ownership of the business they founded with venture capitalists. When a venture capitalist chooses to back a business, it is called an equity purchase or a stock-convertible loan known as a