Venture Capital Characteristics: What Makes It Different

Venture Capital Characteristics: What Sets This Funding Apart

Venture capital characteristics explained: equity funding for new companies, hands-on investors, high risk and return, and long, illiquid holding periods.

By Redaksi Indonesia Artikel

Published March 5, 2021, 9:50 AM WIB 3 min read

Venture capital investing is growing more popular around the world because it plays an important part in driving industry development, tapping large unrealized potential and tackling threats. This kind of financing can take many forms. What makes venture capital different as a source of funding is, at bottom, a set of unique and unifying characteristics.

Venture Capital in a Broader Sense

Venture capital investment essentially finances new companies through equity participation. Such investment sometimes also takes the form of purchasing options or convertible securities, and even long-term loans. Above-average returns are often the main goal behind these investments because they are attractive results. A highly promising venture usually pays back after 5 to 10 years.

Note that venture capital investment covers not only providing equity capital but also providing the skills to nurture the company's development and growth. VCs (venture capitalists) also take an active part in the business and contribute their technology, marketing, planning and management expertise to the company. What further sets this source of funding apart is the spectrum of high risk and high return involved. VC money is invested in exchange for equity shares in the company rather than given as a loan.

Putting a lot of money into a new business is not without risk, above all the risk of losing the money. Venture capitalists (VCs) are aware of every potential risk tied to the cash flow and future profits of the business or company.

Venture Capital Funding

Below are some of the unifying characteristics of venture capital funding.

• Venture capital investments are illiquid and do not allow easy cashing out in the short term. VCs exit their investments through a buyout or an IPO (initial public offering) of the business. A premature IPO can damage a successful business. Likewise, an IPO launched in a poor IPO market can limit the potential proceeds of an exit.

• Venture capital funding has to be held for several years before it is divested. VCs, who dislike illiquidity, charge a liquidity risk premium on their investment. That is why a venture capitalist who can wait for the right moment will benefit from this premium.

• Information, return data and historical risk data are also limited, because VCs more often than not invest in new companies at the leading edge of a sector. The lack of historical data or continuous trading data makes it hard to estimate the probability of success and the cash flow.

Knowledge of financial investing alone is not enough. Given these characteristics of venture capital, skills in advising and in financial and operational analysis are essential. Without them, the company's success will be held back.