The Advantages and Disadvantages of Venture Capital

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Launching and developing a business requires careful planning as well as sources of financing to fund operations and expansion. Small businesses with innovative products and services often have high growth potential, but may be unable to secure large amounts of money necessary to capitalize on their ideas and expand quickly from traditional financing sources like banks. Venture capital -- funds provided by wealthy private investors or venture capital firms -- has pros and cons.

Advantages for Businesses

The primary advantage of venture capital from the perspective of businesses is that it can provide a source of financing to facilitate rapid growth. For instance, if you have a novel business idea but you don't have enough money to effectively bring it to market yourself before competitors enter the market, venture capital might allow you to quickly create and expand the business, gaining market share and brand recognition before competitors enter the market. As a company grows, its value tends to increase, so venture capital can end up making the original owner's stake in the company more valuable.

Disadvantages for Businesses

Venture capital investments involve trading away ownership of a company for funding. When a business owner accepts venture capital, he is no longer the sole owner of the business: he must grant some share of ownership of the business to the venture capital investor. This means that the business does not have to pay back venture capital as it would with a loan, but the original business owner loses complete control over the company. Venture capital investors will have a say in management decisions and may attempt to push the company toward rapid expansion and an exit from the market either by being acquired by a larger company or through an initial public offering.

Advantages for Investors

Venture capital is an attractive investment strategy because it offers the potential for large returns on investment. Venture capital investors often seek out innovate start-up companies and companies in the high-tech industry; such companies can realize dramatic business expansions in short periods. A successful venture capital investment could result in returns greater than what could be gained by investing in things like stocks or large companies, bonds and real estate.

Disadvantages for Investors

The primary drawback of venture capital investing is that it is risky. Pouring hundreds of thousands of dollars into a relatively young business does not guarantee that it will grow quickly. Factors like poor business decisions, fundamental flaws in a business model, changes in economic conditions and competition may impede growth even with ample funding. If a company fails despite attracting venture capital, investors could lose most if not all of their investment.

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