Venture capital

Venture capital is money put into a business by private investors, usually wealthy individuals or specialist venture capital firms, in return for part ownership or control of the business. It is a long-term external source of finance, used when a business needs a large sum.

How it works

An investor agrees to fund the business, often a start-up with a risky but promising idea, and in exchange receives a share of it. That share gives the investor a say in how the business is run and a claim on a slice of any profits or of the money made if the business is sold. Because they are taking a big risk, they expect a big return if things go well.

For example, Jonah wants to open a chain of indoor climbing centres. He needs £250,000 for climbing walls and fitting out the first centre, but the bank will not lend that much to a business with no trading history. A venture capital firm offers the money for 30% ownership and two seats on the board.

Advantages

• Large sums can be raised, far more than a bank would risk on a new business with little track record.
• Investors often bring business advice and contacts, since they have backed many businesses before, saving the owner costly mistakes.
• There are no fixed monthly loan repayments, so a slow month does not force the business to find interest it cannot afford.

Disadvantages

• The owner loses some control. Jonah now has to persuade his investors before changing membership prices or hiring a centre manager.
• Investors expect a say in major decisions and may disagree about how fast to grow or where to sell, which can slow decisions down.
• The investor takes a share of the returns. If the business is later sold, 30% of the value goes to the firm, not to Jonah.

Venture capital is not free money: it suits a business with strong growth potential that can afford to hand over part of itself.