Venture Capital

Venture capital, or VC for short, refers to risk or venture capital. This is a sub-segment of the private equity business. The name venture capital comes from the fact that this form of investment involves a high risk for the investors, as they are investing in very young companies.

A venture capital investment is therefore characterized above all by the fact that the investment involves a high risk, but at the same time there is also the chance of a very high profit. This is due to the fact that venture capitalists primarily invest in very young and innovative companies (start-ups). At the beginning, however, it is often not yet clear to what extent the start-up will be successful and whether an investment will ultimately pay off for the venture capital provider.

How does a venture capital investment work?

As already mentioned, venture capital is a sub-form of private equity. Venture capital companies form a fund from the private resources of investors and use this fund to invest in various promising companies (start-ups). The returns for the investors/venture capital providers do not result from interest or redemption payments, as is the case with lenders, but rather from the sale of company shares at a later date. The venture capital company therefore invests in various start-ups in its portfolio and receives shares in the young companies in return for the capital provided. Hence the name equity financing. In addition to the capital, the venture capital company and the investors also contribute business expertise and their network to the company. In this way, the venture capital providers try to help the young company to grow and increase in value. In the long term, the venture capital providers benefit from this by being able to sell the shares they bought at the beginning at a higher price once the company has increased in value. However, it is not yet clear at the beginning of an investment to what extent the company will be successful or not, which is why this form of investment is associated with a very high risk.

Characteristics of a venture capital investment:

• Investment in young, unlisted companies (start-ups)
• Start-ups with an innovative, scalable business model (usually technology-oriented)
• Participation in the seed, early stage or expansion stage of the start-up
• Participation in the form of equity
• The aim of the equity investment is not to pay dividends or interest, but rather to make a profit from the sale of shares after the company has grown
• High investment risk, as it is not clear whether and how successful the start-up will be.
• In addition to capital, venture capitalists also provide business expertise and a network
• Investors usually take a minority stake but receive information, control and co-determination rights

Financing phases

The risk and the return for venture capital providers is primarily dependent on the timing of their investment. Venture capital investments are possible in various company phases. The different characteristics of the respective phases are explained in more detail in the article on investment phases. In general, however, the earlier a venture capital investor invests, the higher the risk. At the same time, however, the opportunity for very high returns also increases, as the investment quotas are also higher at an earlier company phase due to the high risk.

Phases in which venture capital funds invest:

• Pre-foundation phase (seed stage)
• Start-up financing (start-up stage)
• First growth phase (growth stage)

Pre-seed stage (seed stage)

Investments in the seed stage are used for idea development, research and development. However, this phase of investment involves the greatest risk, which is why venture capital companies rarely invest in the seed phase.

Start-up financing (start-up stage)

In this phase of financing, the start-up already has a finished product or service which can only be produced and marketed with the help of new capital. For investments in this phase, there should be clear indicators of the commercial success of the product.

First growth phase (growth stage)

In this phase, the product is already successfully established on the market. Future investments are primarily aimed at financing further growth and expanding production capacities.

Types of venture capital investors

In addition to the different times at which venture capital can flow into a start-up, there are also different types of investors who provide venture capital.

Classic venture capital companies

• Company acts as fund manager / asset manager
• Company creates funds with a special investment focus
• The company looks for investors and uses the investors' capital to invest in companies that fit into the respective portfolio
• Minimum investment volume: over €50,000
• The industry focus increases the expertise and know-how that the venture capital providers can contribute

Venture capital from development banks

• Development banks that invest in young and innovative companies through venture capital
• Minimum investment volume: € 20,000
• Any business model is eligible
• Industry expertise comparatively low

Corporate venture capital

• Subsidiaries of large companies that make strategic investments

Large VC funds in Germany:

High-Tech Gründerfonds

• Germany's most active early-stage investor (seed phase)
• Investments in technology-oriented companies
• Mainly investments in B2B companies
• Most represented sectors are healthcare, IT and communication as well as pharmaceuticals
• is financed by KfW, BMWi and private companies
• participates with at least 15
• Capital strength and expertise are combined

Coparion Fund

• Similar to High-Tech Gründerfonds
• Focus is on Series A financing
• Acts exclusively as a co-investor, i.e. another investor must provide venture capital on the same terms

In search of venture capital

If you have not yet decided which venture capital provider is the right one for you, it is worth doing extensive research first. Every venture capital provider has a specific investment focus or a preferred start-up phase in which they like to invest. To get a good overview, it is worth taking a look at our investor database: /investors/ Here you have the option of filtering by federal state, investor type (in this case VC), company phase and many other indicators to find the ideal investor for you.

Exit

The participation of venture capital companies is by no means intended to last forever. The aim of a venture capital investor is to invest in a young company that is growing successfully and whose shares can be resold at a high profit. The average investment period of a venture capital company is usually between 2 and 7 years. At the end of this investment is the so-called exit, i.e. the sale of the venture capital investor's company shares and the associated exit from the company. There are various ways of selling shares - also known as exit strategies.

Exit strategies:

1) Initial public offering:

One of the most common exit strategies is the initial public offering (@IPO): Here, the company in which the venture capital investor has invested is so successful that it goes public. When the company is listed on the stock exchange, its shares are sold on the market and the venture capital provider receives the proceeds for its investment.

2) Trade sales:

Exit through the takeover of the start-up by another company, usually from the same sector.

3) Secondary sale:

The venture capitalist sells his company shares to a third party.

4) Company buy-back:

The founders reacquire the venture capitalist's shares.

5) Liquidation

Liquidation is the worst-case scenario in which a company has to be liquidated if it does not survive on the market. In this case, the venture capitalist does not receive back the capital from his investment.

However, liquidation is the worst-case scenario for the venture capitalist; venture capitalists normally achieve average returns of 15-25% on their investments.

Incentive problems:

One of the biggest problems with venture capital investments is the asymmetrical distribution of information between the venture capital firm on the one hand and the entrepreneur on the other. If a venture capitalist makes capital available to an entrepreneur in the form of an investment, the latter cannot see whether the entrepreneur is actually using the available money in his interests, i.e. to increase the value of the company.

In order to minimize these incentive problems, VC companies are granted various control rights, e.g:

• The capital from VC companies is made available in several stages, with further money only flowing when certain milestones have been reached.
• Venture capitalists have various rights of intervention.

Summary

In summary, it can be said that a venture capital investment promises several advantages for a start-up, as venture capitalists invest in very early company phases in which access to outside capital is usually still denied to a start-up due to the high risk involved. In addition to the necessary capital, VC companies also contribute their industry knowledge and networks to the company and help it to grow. However, venture capital companies often also receive large shares in the young company and can also influence the company through various intervention and control rights. So if you prefer to remain independent here, you should consider other forms of financing such as bootstrapping or @crowdfunding.

On the part of venture capitalists, such investments are of course associated with high risks, but they also offer the opportunity to achieve very high returns if the start-up in which they invest becomes successful at a later date. Venture capital companies naturally aim to multiply capital in this way. However, in order to reduce their own risk, investments are usually made via so-called venture capital funds, which put investors' money into several companies if some investments do not lead to success.

Other spellings:

Venture capital, risk capital, venture capital, venture capital, risk capital