Venture capitalists aren’t financing companies out of the kindness of their hearts (of course, neither are angel investors or lenders). As we said, they get equity in the businesses that they fund. And with any luck, that equity will turn into a big payday.
See, VC firms like to invest in companies that have big growth potential. They hope that, with a little bit of funding, the companies they invest in will get bigger and bigger, until they can have an initial public offering (IPO).
When that happens, anyone with existing equity in the business—like the founders or the investors—can cash out by selling their shares. And that’s exactly what venture capitalists want to do. They’ll sell their shares, hopefully at a big profit, and move on to fund the next company.
Of course, that only happens if everything goes well. Some 90% of startups fail.2 And if VCs invest in a company that fails, they never get that big payout. So venture capital investments are actually a pretty risky business.
Which is why VC investors are kind of picky about their investment choices. They seek to invest in businesses that have plenty of potential for expansion, like technology and science-based companies. And they don’t want to fund brand-new companies still in the seed stage either—VC investing typically comes after a couple rounds of fundraising (perhaps with angel investors).
That big financial risk is also why venture capital investors take a big chunk of equity from the companies they give money to. After all, VC investors want to be sure they get a good return on investment if things go well. That’s why, according to estimates, you can expect a VC firm to ask for anywhere between 25% to 50% equity of the companies they invest in.3