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The basics of venture capital

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Whether your business is in the early stages of development or already thriving and seeking growth capital, you will need to determine whether venture capital financing is right for your company — and if so, how do you get it.

Venture capital, also often referred to as equity capital, is money raised by a business in exchange for a share of ownership in the company. Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time. Two key sources of equity capital for new and emerging businesses are venture capital firms and angel investors, high net worth individual investors who seek high returns through private investments in start-up companies.

Typically, angel capital and venture capital investors invest capital unsecured by assets to young, private companies with the potential for rapid growth in the hope of profiting from their investment. Such investing covers most industries and is appropriate for businesses across the spectrum of developmental stages. Investing in new or very early companies inherently carries a high degree of risk. But venture capital is long term or “patient capital” that allows companies the time to mature into profitable organizations.

Successful long-term growth for most businesses is dependent upon the availability of equity capital. Lenders generally require some equity cushion or collateral before they will lend to a small business. A lack of equity limits the debt financing available to businesses. Small businesses often rely on venture capital to provide a fresh injection of equity, which can allow the company to seek new debt.

Angel and venture capital investors usually seek active involvement in the company, and almost all venture capitalists will, at a minimum, want a seat on the board of directors. Because of their business experience, many venture capitalists and angel investors invest more than their money. They also seek active involvement in the business, such as consulting and mentoring the entrepreneur. They often take bigger risks or accept lower rewards when they are attracted to the nonfinancial characteristics of an entrepreneur’s proposal.

Although investors are committed to a company for the long haul, that does not mean indefinitely. The primary objective of equity investors is to achieve a superior rate of return through the eventual and timely disposal of investments. A good investor will be considering potential exit strategies from the time the investment is first presented and investigated.

Venture capitalists and angel investors share many common characteristics: They seek companies with high growth potentials, strong management teams and solid business plans to aid the angels in assessing the company’s value. They typically invest in ventures involved in industries or technologies with which they are personally familiar.

The U.S. Small Business Administration operates a venture capital program called the Small Business Investment Company (SBIC) Program. Since 1958, this program has provided about $40 billion in venture capital to American small businesses. Many small businesses that received financing through the SBA’s SBIC program have gone on to become household names, including Federal Express, Intel, Apple Computer, Callaway Golf, Outback Steakhouse and Staples, to name just a few.

Entrepreneurs interested in seeking SBIC financing can visit the venture financing page on the SBA Web site at www.sba.gov/INV/forentre.html. The Web page includes several useful articles on venture capital for entrepreneurs, including How to Seek SBIC Financing, Venture Capital 101 and A Venture Capital Primer for Small Business. The page also includes a directory of 435 operating SBICs, listed by state.

Small Business Success

After seeking advice from friends who were already in the transportation business, Edward Stanton started his airport shuttle firm — A North County Coastal Sedan — in April 2002. Prior to starting his business, Stanton was a taxi driver for five years. After years of driving for an employer, he decided he would rather work for himself.

Stanton manages his business on a day-to-day basis, dealing with any issues as they arise. Recently, he recognized a need for some additional capital to ease cash flow constraints. He solved money problems by applying for an SBA guaranteed loan through U.S. Bank. Proceeds from the loan will provide Stanton with capital to expand his business by purchasing more vehicles and hiring additional drivers over the next two years.

In addition to providing federal guaranteed loans to small businesses, SBA offers a variety of free and low-cost training workshops and consulting services to current business owners and budding entrepreneurs through our resource partners: SCORE: Counselors to America’s Small Business, Small Business Development Centers and Women’s Business Centers.

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