The driving (financial) force behind the 90's explosion of startups all over the world. Basically, a VC is a person or a group with a lot of money. They either seek out, or are approached by individuals with some idea that they need cash for. These ideas can range from new designs of a tuning fork to a new company.

The name come from the fact that the VC is risking (read: venturing) his money (read: capital) on the proposed idea.

Venture capital organizations can an important source of funding for young (and, in some cases, expanding or troubled) businesses. VC firms may make investments at several stages:
  1. The seed money stage, where an individual or organization has only an idea, but no funding to speak of. My sense is that these are not too common.
  2. The rather prosaically named second stage, after the business's founders have made as much use of possible of their own seed money and loan capital. This is probably the most common type of VC investment.
  3. The mezzanine level, after a business has matured and may be ready for an initial public offering (IPO). Investments at this stage present much lower risks to the VC group, as the underlying business is already on its feet.

Significantly, VC groups can provide more than financial resources: because they specialize in investing in businesses that may be at a critical juncture in their development, they may also be able to provide sage advice and guidance to a business's management. Consistent with this, many VC groups focus on investing in companies in one industry in which the group's principals have expertise.

Venture capital groups may be compensated in a variety of ways. Most frequently, their investment effectively buys a chunk of the business, and they become a major shareholder when the company makes its IPO. In some cases, the VC firm may opt for a share of the sales/royalties of the underlying business's new product or service.

In short, VC firms provide an important source of capital for businesses, filling the gap when banks are unwilling to make loans and the business is to small to offer its shares publicly.

Some material was adapted from Barron's Dictionary of Finance and Investment Terms.
Venture capital is undeniably important, but it can have its down side. Part of the venture capitalist's job is to nurture your company to fruition, which means an IPO, an acquisition, or long-term independent success. This means the VC will demand a place on your board of directors. Subsequently, they may feel the need to change your attitude, or just kick you out.

I once saw Tim Draper, a very powerful Silicon Valley VC, brag about how he took Hotmail public. It was Draper's idea to put an ad at the bottom of every Hotmail message (you know, "Get your free e-mail at Hotmail" or whatever), but the founders balked because they considered it to be spam.

Draper was outraged. He pressured the Hotmail founders intensely until he'd pushed them into his way of thinking, an act he was fiercely proud of. The conclusion he drew in his speech was that in order to work with "these people" (his exact term), you had to snuff out their petty principles and make them realize that the money is all that counts.

I'm not taking him out of context. Draper is openly sneering and derisive of the ideals that get in the way of the money.

There's nothing wrong with wanting to make big money, and if that's your primary objective, the VCs are the way to go. And it is their money, after all. If they're funding your survival, they ought to have a say in what you do. Just be aware -- especially if you've got any non-monetary goals for your company, or any ideals you want to preserve -- that their interests trump yours. You just might find yourself body-checked into the gutter while your former buddies go for cocktails with Microsoft.

Even if your VC respects you, he/she can make life hard with stupid decisions, demanding that you "get the name out there" via premature vaporware press releases or unnecessarily costly trade-show booths. And then there are the vulture capitalists who just want to leech off of your hard work.

The price of venture capital is the control you once had over your company. Choose carefully.
