Investors with high levels of wealth and a willingness to accept risk and entrepreneurs with no money with which to realize their business ideas come together in private venture capital markets. The investors supply funds to young businesses in the hope that they will profit when the business matures. The rewards in the market can be large, but the rate of failure is high for start-up companies.
Private venture capital is usually supplied by wealthy individual investors, groups of individuals who have pooled their wealth or institutional investors like endowment funds. When the capital is supplied by a group, they generally form a limited partnership, creating a limited liability company to act as the general partner. They may hire a manager to make the decisions about where their capital will be invested. Individual investors and institutional investors may supply the capital directly.
Entrepreneurs receive funds from venture capital investors in the first stages of the establishment of their businesses. In return, entrepreneurs must provide investors with detailed reports on the functioning of the business. Investors may place certain restrictions on their funds, forcing the entrepreneurs to follow business practices the venture capital investors believe to be reliable. If the company does succeed, the investors who supplied the venture capital realize a profit by selling their shares in the business either to the entrepreneurs or to other investors in an initial public offering.
Private venture capital is technically a part of private equity. The activities that comprise venture capital investment are a subset of the investments available to private equity investments. In theory, a private equity firm may have a venture capital division while it maintains other types of investments.
In practice, there has traditionally been a distinction between private venture capital and private equity, with investment firms specializing in each. Both deal in the provision of capital to companies, but venture capital usually means the investments are made in the initial stages of company formation. Private equity is usually supplied after the company is already established. The difference between the two, however, has become less distinct as investors have moved into new avenues of investment.
The blurred distinctions between private venture capital and private equity investments mean that private venture capital investors may engage in behavior that is traditionally considered to be in the purview of private equity investors. This includes activities like leveraged buyouts, in which investors acquire failing firms and attempt to turn them into viable businesses to make a profit. It also includes expansion activities and outside investments that generate short-term returns that make further investment possible.