When venture capital firms or funds invest in startups, early-stage, or developing businesses, they are looking for companies that have high growth potential or have shown strong growth in the past (in terms of number of employees, annual revenue, scale of operations, etc). Entrepreneurial venture capital businesses or funds make investments in these early-stage enterprises in return for equity, or a share in the company's ownership. Venture capitalists take on the risk of funding high-risk start-ups in the hopes that some of the companies they back will go on to become successful enterprises. Because startups confront a high degree of uncertainty, venture capital investments have a high failure rate. They are often founded on a new technology or business strategy, and they come from high-tech sectors such as information technology (IT), clean technology, or biotechnology, to name a few examples.
It is common for venture capital investments to be made following a first round of "seed financing." The Series A round of institutional venture capital is the initial round of money raised to support expansion of an organisation. In exchange for this financing, venture capitalists hope to generate returns through an eventual "exit" event, such as the company selling shares to the public for the first time in an initial public offering (IPO), or the disposal of shares occurring through a merger, a sale to another entity such as a financial buyer in the private equity secondary market, or a sale to a trading company such as a competitor.
Venture capital is also a method through which the private and public sectors may work together to establish an institution that methodically builds business networks for new companies and industries, allowing them to grow and prosper. This institution assists in the identification of potential new businesses and the provision of financial resources, technical knowledge, mentorship, personnel acquisition, strategic collaboration, marketing "know-how," and business models to these businesses. These companies are more likely to thrive if they are connected into the business network, since they become "nodes" in the search networks for developing and producing goods in their domain after they have been integrated. However, venture capitalists' choices are often skewed, displaying characteristics such as overconfidence and the illusion of control, which are common to entrepreneurial decisions in general.