Venture capital – what is it and how does it work? List of venture capital funds

Venture capital is a key pillar of support for innovative start-ups, enabling them to grow rapidly and realise ambitious projects.

From this article you will learn:

• What is venture capital?
• What are the types of venture capital?
• How does venture capital differ from other forms of funding?
• How do venture capital funds work?
• Who are the beneficiaries of venture capital funds?
• How do I engage with a venture capital fund?
• What are the limitations of venture capital funds?
• What can be gained from venture capital funds?

Venture capital – definition

Venture capital (VC) is a form of funding that is provided by investors to startups and young companies that have the potential for rapid growth but also involve high risk. They often do not have access to traditional sources of funding, such as bank loans or issuing shares on the stock market, and VC allows them to raise the capital they need to grow in exchange for an ownership stake in the company.

The history of venture capital (VC) is rich and varied and can be traced back to ancient times, although the modern form of VC did not begin to take shape until the 20th century. An interesting comparison between the nineteenth-century whaling industry and modern-day venture capital has been drawn by Professor Tom Nicholas of Harvard. Whaling was a profitable but risky venture, similar to today’s start-ups that need capital to get off the ground^[1].

Private enterprise financing was usually the preserve of wealthy individuals and families, such as the Morgan, Rockefellers and Vanderbilds. Later, as part of the Industrial Revolution, wealthy investors financed the development of technologies such as the ‘spinning Jenny’ spinning machine and the construction of railways that connected cities across the United States.

Modern venture capital began to take shape after the Second World War, with a key moment in 1946 when the first venture capital firms – American Research and Development Corporation (ARDC) and J.H. Whitney & Company – were formed. ARDC, founded by Georges Doriot, a professor at Harvard Business School, was pioneering in the sense that it raised capital from mutual funds, insurance companies and universities, a breakthrough from earlier funding models that relied mainly on raising capital from wealthy families or banks^[2].

Arthur Rock, an investor, became famous for funding Fairchild Semiconductor, which had a huge impact on the development of the semiconductor and technology industry in Silicon Valley, marking a milestone in the history of venture capital.

A venture capital fund is a financial institution that invests capital in young, innovative companies with high growth potential.

Definition of venture capital.

Venture capital has evolved over the decades, passing through different phases, from the ‘First Wave’ in the 1960s and 1970s, when investments were mainly focused on the expansion of companies, to the ‘Fourth Wave’, characterised by globalisation, the development of technology and an increasing variety of financing models.

Types of venture capital

Venture capital (VC) can be divided into several stages of investment, and each stage relates to different phases of a company’s development. Here are the main types:

• Pre-seed/Seed – this stage of investment refers to the very early stages of a start-up’s life. Often the company does not yet have a full product or recurring revenue. Investment in this phase is usually relatively low and is for concept development, prototyping or market testing. It is also characterised by very high risk, and many start-ups do not pass through this stage successfully.
• Early-stage/Start-up – at this stage the company may already have a working product and some revenue, but is not yet profitable. Investment in this phase is for developing the product, building the team and starting marketing activities. Risks still remain high, but are somewhat lower than in the seed phase.
• Series A, B, C (etc.) – these are successive funding rounds for growing companies. Each subsequent round usually means a larger investment as the company grows and needs more capital for expansion. The funds can be used for scaling, international expansion or new product development. The risk decreases with each round, but it still exists.
• Late-stage/Growth – at this stage the company is already well established in the market and has a steady source of income. Investments in this phase are for further expansion, acquisitions of other companies or preparation for listing. The risk is lower than in the earlier stages, but still exists.
• Mezzanine/Bridge financing – this is a type of financing designed for companies that plan to go public or be acquired in the near future. It helps in the transition from VC financing to the public capital market. In this case, the risk is much lower because the company is on the verge of a major financial breakthrough.
• Corporate VC – large corporations often have their own venture capital units that invest in startups. These investments are often motivated not only by profit, but also by strategic advantages such as access to new technologies. The risk depends on the corporation’s strategy and investment profile.

Venture capital versus other forms of financing

Venture capital is just one of many forms of financing available to companies, especially those in the early stages of development. Others include:

• Bank loans are traditional loans provided by banks. Unlike VCs, loans must be repaid within a certain period of time, usually with interest. Banks usually require collateral and carefully analyse a company’s creditworthiness before granting a loan.
• Large companies can raise capital by issuing shares on the stock market. Unlike VCs, where investors buy shares directly from the company, a share issue allows individual and institutional investors to buy shares on the open market.
• Business angels are individual investors who invest their own money in young companies, similar to VCs. They typically commit smaller amounts and often take a more active role in the management of the company.
• Crowdfunding allows entrepreneurs to raise money directly from people who believe in their project. There are various crowdfunding platforms that allow you to raise capital in exchange for rewards, shares or even loans.
• Some companies qualify for grant funding from governments or non-profit organisations. Unlike VCs or bank loans, grants do not have to be repaid.

The relationships between these forms of funding are complex. Often companies use several sources at the same time, depending on their needs and situation. For example, a start-up may first obtain funding from a business angel and then, when it has reached a certain level of development, turn to a venture capital fund for capital. Later, once the company is large and stable, it may decide to go public and raise capital by issuing shares.

How venture capital works

Venture capital works by investing capital in young, high-growth companies that have the potential to grow quickly, but the investment is high risk. Venture capital funds come from a variety of investors – institutions, individuals and corporations. When a VC fund decides to invest in a start-up, it does so in exchange for shares in the company.

The investment process begins with a due diligence phase, during which the fund carefully analyses the start-up’s potential, team, market, product and finances. If the analysis is positive, the VC fund begins to negotiate the terms of the investment with the company’s founders. Once these are agreed and capital is invested, the VC fund becomes a co-owner of the company and is often given a seat on the supervisory board, allowing it to influence strategic decisions.

The VC fund’s goal is to achieve the highest possible return on its investment, so it expects the company to increase its value significantly within a few years, allowing it to sell the shares at a profit. This can be done through a second round of investment with another fund, the sale of shares on the stock market (via a public offering) or the sale of the entire company to another company.

During the course of the investment, the VC fund often provides the start-up not only with capital, but also with support in the form of knowledge, experience and contacts, and helps to recruit key team members and establish business partnerships.

Beneficiaries of venture capital funds

The beneficiaries of venture capital (VC) funds are the various entities that benefit directly or indirectly from their activities. Start-ups and entrepreneurs are the main target of VC investments. They provide them with the capital they need to grow, scale and expand their business. They can create new jobs, offer competitive salaries and benefits, which translates into benefits for employees. They can also bring innovative products and services to market faster.

Investors in VC funds, i.e. individuals, financial institutions, pension funds and others who invest their money in VC funds, become beneficiaries when the funds achieve a high return on investment. As VC-funded startups grow, their demand for third-party products and services increases, which can lead to increased business for suppliers, business partners and other collaborators.

Working with venture capital funds

To attract the attention of a venture capital fund, a start-up needs to develop a well-thought-out business plan that clearly outlines the business model, financial projections, target market and growth strategy. Having a competent team is also key, as investors often emphasise that they invest in people. Many companies also try to create a Minimum Viable Product (MVP) before asking for funding, which gives investors confidence in the concept’s viability.

When a start-up is ready to present, active networking through attendance at industry conferences and meetings is important. Many investors value recommendations from trusted sources, so it is also worth taking advantage of introductions by industry insiders.

If the fund is interested, the next step is the presentation, or pitch. During this meeting, the start-up should clearly present its vision, the added value of the product and the market potential. If the presentation is received positively, the fund will proceed to the due diligence stage, i.e. a thorough examination of all aspects of the start-up, from finances to technology and team. If this stage is also successful, the negotiation of the investment terms will begin – a complicated process in which it is advisable to use specialists, especially lawyers specialising in VC transactions.

After a successful investment, the cooperation between the start-up and the VC fund does not end – a representative of the fund often joins the supervisory board. Often the cooperation continues until the VC fund wants to realise a return on the investment, which is called an ‘exit’. This may involve selling shares to another investor, taking the company public or selling the entire start-up. Both the fund and the founders should be prepared for such scenarios and work together to achieve a mutually beneficial outcome.

Limitations of venture capital

Venture capital funding is not available to all companies – VC funds tend to look for companies with high growth potential and significant returns on investment. Companies operating in less attractive sectors may find it difficult to obtain such funding. Working with VCs also involves certain compromises. Entrepreneurs often have to give up part of their stake in their company, which means diluting their shareholding. They may also lose some control over the direction of the company, especially if a fund representative joins the supervisory board.

VC funds also have specific return expectations. They often expect a company to deliver multiple returns over a certain period of time, which can put pressure on the company to pursue rapid growth, sometimes at the expense of stability or long-term strategy. It is also worth noting that not all VC investments are successful.

Advantages of venture capital

With venture capital, companies can access significant funding, allowing them to scale and grow faster. This form of funding is often more accessible to start-ups than traditional bank loans, especially for companies that do not yet have solid revenues or profits. Working with VC funds also brings the added benefit of investor experience, knowledge and contacts. It can also increase the credibility and visibility of the company. Being associated with a reputable VC fund can attract the attention of the media, customers and other investors.

VC funds can also support entrepreneurs in difficult times, helping them through crises or guiding them through complex negotiations. It is also worth mentioning that venture capital allows entrepreneurs to share risk with investors. Start-ups are high-risk ventures, so having a partner who is willing to support the company financially and advise on key issues can be invaluable.

List of venture capital funds

The venture capital (VC) market ecosystem in Poland and abroad is diverse, with both Polish and international VC funds playing an important role in funding innovative companies at various stages of their development.

LT Capital, SMOK Ventures, Movens Venture Capital, and Market One Capital topped the list of the most active Polish VC funds in 2022^[3]. In turn, Innovation Nest opened the list of the largest active venture capital funds in Poland in 2022^[4].

Among international venture capital funds, in turn, we can mention Sequoia Capital, Accel, and New Enterprise Associates – these are some of the leading international venture capital funds that invest in innovative start-ups around the world^[5]. Also, funds such as Andreessen Horowitz and Lightspeed Venture Partners are known for their significant investments in innovative companies in the US, and their reputation in the VC market is highly regarded^[6].