What is a Venture Capital Investment?

A venture capital investment is a type of investment in which a venture capitalist invests cash assets into a new business venture in exchange for convertible preferred stock in the company. Typically, this preferred stock can be converted to common stock, either at the request of the holder or when events specified in the agreement between the investor and the company occur. There are several benefits associated with this type of investment, including protection of the venture capitalist’s investment in the event of a merger or the liquidation of the company.

As part of the venture capital investment, investors usually receive specific rights and privileges in exchange for supplying the influx of cash. It is not unusual for the investor to have input into the election of at least one member of the company’s board of directors. Should the company decide to make a public offering, the investor has the right to register his or her shares for sale. In many instances, the venture capitalist also has the right to maintain a consistent percentage share of ownership in the business, with that right often including opportunities to purchase additional shares of stock before those shares are offered to the general public.

In terms of protecting the rights of the investor, a venture capital investment approach also provides precedence in the event that the business fails and the assets must be liquidated. Since the shares held by the venture capitalist are preferred, reimbursement for those shares occurs before any payments are remitted to investors holding shares of common stock. In the event that the company merges with another corporate entity, the terms of a venture capital investment often require that the investor has opportunities to convert to common stock offered by the company created by the merger, or to share his or her shares at competitive rates.

It is important to clearly identify how the relationship between investor and company will function. This means identifying up front how much money is invested initially, the number of shares of convertible preferred stock that the investor will receive, and when those shares can be converted into common stock. It is also important to determine what occurs when the business makes its initial public offering or IPO, and what events may occur that would require the investor to provide more cash as part of the investment. Taking the time to clearly define each step of the relationship in advance means both parties know what is expected and what must take place if and when certain events take place.