Venture Capital
and Economic Development
Venture Capital (VC) funds are funds invested in or available for investment in potentially highly profitable business ventures at considerable risk to the investor. In exchange for their investment in a company, venture capitalists receive an equity stake in the company such as preferred shares and options that give the investor part ownership in the company. Venture capital is considered high risk capital because the investments aren't guaranteed. Equity stakeholders are considered part owners of the company. All other claims must be paid before equity investments can be repaid.
Stages of Venture Capital Investments
Seed financing is an investment made very early in the development cycle of the business. Seed financing provides funds for research and prototype development. Start-ups refer to firms that have completed successful product development and market research but have few, if any, commercial sales. First stage financing is provided to companies that have begun commercial production but require additional financing to initiate full scale production. Second stage financing is provided for the initial expansion of a company that is producing and a saleable product that hasn't yet shown a profit. Mezzanine financing is investment intended to provide funding to further expand the product and to firmly establish market share. Bridge or buyout financing is needed for restructuring or when a company is planning to go public.
Benefits and Risks
Venture capital investment was responsible for the creation 5.6 million new jobs in 2000 and $956.8 billion in revenue (Arnstein, 2003). Amazon, Cisco, Compaq, eBay, Federal Express, Starbucks and Staples all received venture capital investment. Venture capital investments are highly speculative. The SEC reports that for every 10 businesses funded through venture capital, 7 or 8 will fail or fail to turn a satisfactory profit.
Venture Capital and the Public Sector
New Markets Venture Capital (NMVC) Program (2000). Privately managed for profit investment companies that are designed to attract equity capital to lower income areas. NMVC companies have to raise a minimum of $5 million of private capital for investments from sources other than the Federal Government. The SBA provides NMVC companies with matching investment funds in the form of SBA guaranteed deferred payment debentures and matching operational assistance grants. Certified Capital Companies (CAPCOs) are state certified venture capital companies funded by insurance companies Under CAPCO, insurance companies receive tax credits for investing in CAPCO certified investment firms. The firms are required to use the certified private venture capital funds, minus management and overhead fees, to invest in specific types of businesses within the state.
Venture capital investment tends to be targeted toward certain industries and geographic locations. Venture capitalists seek out opportunities with the highest rate of return. Public sector sponsored VC programs are targeted to blighted, low income and underdeveloped markets that mainstream venture capital firms wouldn’t enter. Public sector sponsored VC programs must have sufficient capital to operate for a number of years without any cash flow.