Risky but High Potential Return Nature of Venture Capital Investments
Risky nature of venture capital investments
A crucial aspect of venture capital investment is the ability to identify novel technologies at a very early stage that have a potential of generating huge return within just a number of years’ time. This is because when a venture capitalist invests in a startup company, the company is still in its early stage of development. That’s how we call the company – a startup! It is likely that the company is still in its R&D stage, or has just passed its initial prototype stage. In other words, the technology the startup company is developing is still not so mature, and may even be unproven.
Potential return – from startup to IPO
However, when a VC invests in a startup company, he has two possible exit options in his mind – (i) IPO; and (ii) trade sale. Ideally, the VC is looking to bring the startup company to an IPO within a number of years (typically, 3-5 years), so that he can then sell his shares publicly (subject to any lock-up period).
Alternatively, if an IPO is not possible, for example, because the company is not performing well, or the economy is down, then the VC has to look for alternative exit option – trade sale. What that means is that the VC will be selling his shares in the startup to a third party, or to one of his other portfolio companies if the business is related. (On a legal point, this is where drag-along and tag-along rights come into play).
Trade sale
The investor will have to go for a trade sale if an IPO is not possible. An IPO may not be possible for various reasons – for example, if the company is not doing well, if the company is losing money, if the economy is down, or simply if there is a very attractive offer from a third party. Therefore, a trade may be a good thing or bad thing. But, the ideal exit option is IPO.
Examples of venture backed companies
Examples of venture backed companies include Google, Microsoft, Intel, Apple, Starbucks, Intel, Facebook, FedEx.
Conclusion
In the ideal scenario, a startup company goes from startup to IPO within just a number of years’ time. If an IPO is not possible, the VC may hold on to the company for a few more years. If not, a trade sale will occur.
Related posts:
- Venture capital exits – trade sale vs IPO – compared and analyzed
- From Seed Capital to Angel Investors to Venture Capital Funding – Startup Company Financing Model
- Calculate pre-money valuation of startup company seeking venture capital funding
- How to Calculate Liquidation Preference of Preferred Stock in a Venture Capital Financing?
- Pre-money, Post-money Valuation and Calculation in a Venture Capital Investment
- What is Series A Convertible Preferred Stock Funding and Financing in a Venture Capital Investment?
- Sample liquidation preference clause in a typical venture capital term sheet
- Download Sample Share Cap Table Template of a Venture Capital Term Sheet
Great article