Venture capital networks, or clubs, are groups of individual and institutional investors that provide financing to risky, unproven business ventures. Like other providers of venture capital—which may include professionally managed investment funds, government-backed Small Business Investment Corporations (SBICs), or subsidiaries of investment banking firms, insurance companies, and corporations—members of these networks generally invest in private startup companies with a high profit potential. In exchange for their funds, the venture capitalists usually require a percentage of equity ownership of the company, some measure of control over its strategic planning, and payment of assorted fees. Due to the highly speculative nature of their investments, venture capitalists hope to achieve a high rate of return over a relatively short period of time.
The main difference between venture capital networks and other venture capital providers is their degree of formality. Venture capital networks are informal organizations that exist to help entrepreneurs and small businesses connect with potential investors. Before the advent of networks, it was extremely difficult for entrepreneurs to gain access to wealthy private investors, also known as “angels” or “adventure capitalists.” The networks—which may take the form of computer databases or document clearinghouses—basically provide “matchmaking” services between people with good business ideas and people with money to invest. In contrast, formal venture capital firms are professionally managed organizations that exist to earn a high return on funds by investing in new and growing companies. These firms are typically highly selective about the companies in which they invest, meaning that venture capital from these sources is not available to the vast majority of startup businesses.
According to Nation’s Business, wealthy private investors provided American small businesses with $10 to $20 billion annually during the mid-1990s. In the early 2000s the venture capital market slowed dramatically. However, according to Second Venture Corporation, a venture capital network dedicated to helping entrepreneurs find funding with which to start businesses, “The current venture capital market [in early 2006] is rebounding nicely, from the past setbacks of the dot com bubble.
Venture capital remains a viable source of funding for startups, which are able to deliver the necessary growth that investors are looking for. Past events should certainly not discourage entrepreneurs who have genuine winning ideas and business plans from looking for funds.”
The membership of venture capital networks consists primarily of wealthy entrepreneurs who recognize both the financial potential of new businesses and the importance of capital in the early stages of a business’s life. In many cases, these investors wind up sitting on the boards of the companies they fund, where they can provide valuable, firsthand management advice based on their own experiences.
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How Networks Work
In the past, it was extremely difficult for entrepreneurs to find and make contact with private investors. In response to this problem, many business groups and universities created networks to help entrepreneurs gain access to interested investors. One of the earliest such efforts was the Venture Capital Network, a computer database that was established by a professor at the University of New Hampshire. This and other computerized networks are similar to computer matchmaking services. Each entrepreneur posts a business plan and a set of financial projections on the network, while each investor submits information describing his or her interests and investment criteria. Due to their previous business experience, different investors may be most interested in investing in companies of a certain size, in a certain industry, or with certain capital requirements. The computer then provides participants with a list of possible matches. Interested parties are left to make contact with one another and try to reach an agreement.
Non-computerized venture capital networks operate in basically the same way. A central clearinghouse solicits business plans from companies seeking capital, then distributes profiles of the companies to private investors who belong to the network. If a certain investor wants to know more about a particular company, he or she might arrange for a formal presentation. In many cases, both business and investor profiles are distributed anonymously—without names attached—until both parties express an interest in proceeding further. Another similar type of arrangement can be found in a private investment club. These are community-based organizations in which several individuals pool their resources to invest in new and existing businesses on a local level. Such clubs generally solicit business plans and then distribute them to members, but then invest as a group.
The financing provided through venture capital networks can range dramatically in size from investments of $25,000 to more than $1 million (the majority of financing deals are under $100,000). Entrepreneurs searching for venture capital assistance usually pay a small fee to participate in a network—typically less than $500 annually—and institutional investors may pay a somewhat higher fee. Although venture capital networks are usually better sources of funding for startup companies than formal venture capital firms, merely joining a network does not guarantee that a small business will obtain financing. There are usually at least two companies for every one investor listed in databases. In addition, even if a match is made, the entrepreneur still must sell the investor on the proposal and negotiate a mutually beneficial agreement.