Venture Capital

A young company often has an idea, but no money. A bank usually won’t give it a loan, because it can show neither profits nor collateral. This is where investors step in who provide venture capital. They give the company money and receive a stake in the firm in return. If the company goes bankrupt, the money is gone. But if it grows large and is sold or taken public, the stake is worth many times its original value. The English term for this is venture capital, and in German it is also called Wagniskapital.

Why almost every AI startup depends on it

Especially in the AI industry, venture capital is the standard route to financing. The reason lies in the costs. Training a capable language model often costs hundreds of millions before even a single customer has paid anything. No young company can raise that sum from its own revenue. Without outside investors, most of today’s AI companies simply wouldn’t exist.

For investors, this is a game with very unequal outcomes. Of ten investments, typically seven or eight fail completely. One or two hits therefore have to be big enough to cover all the losses and still turn a profit. This calculation explains the industry’s behavior. Investors aren’t looking for solid small companies, but for candidates capable of extremely rapid growth.

This also creates a pressure that is often overlooked in the news. A company backed by venture capital has to grow fast, not merely operate profitably. A company that after a few years has only stable revenues is still considered a disappointment by its backers. That’s why many startups spend money on gaining market share rather than on profits.

From the seed round to the exit

Venture capital doesn’t flow in a single payment, but in stages. The first is called the seed round, meaning seed money, and often ranges from a few hundred thousand to a few million euros. This is followed by further rounds named Series A, Series B, and so on. Each round brings more money, but only if the company has shown progress beforehand. Such progress can be user numbers, a finished product, or the first paying customers.

At each round, a value is set for the entire company: the valuation. Anyone who pays in ten million euros while the company is valued at a hundred million receives ten percent of the shares. This valuation isn’t a measured price but a matter of negotiation. Above all, it reflects what the investors believe the company is capable of. That’s why valuations can also fall again quickly.

The investors' money usually doesn’t come out of their own pockets. A venture capital firm collects it from pension funds, insurance companies, and wealthy individuals and manages it in a fund. After about ten years, these backers want their capital back. That’s why every investment is working toward an exit. This is either a sale to a larger corporation or an initial public offering.

How to recognize venture capital in the news

Reports about venture capital can be recognized by a fixed formula. It typically reads something like: a startup raised two hundred million dollars in a Series B round, at a valuation of two billion. What matters here is the difference between the two figures. The first is real money flowing into an account. The second is merely an estimate that no one actually receives as a payout.

Well-known names in this industry are Andreessen Horowitz and Sequoia Capital, both from Silicon Valley. In Europe, Index Ventures and Balderton are among those active. A special category is formed by large tech corporations that invest in startups themselves. Microsoft's investment in OpenAI or Amazon's and Google's investments in Anthropic are examples of this.

A common misconception is that a high valuation is proof of success. It only shows that investors believe in future profits. Many highly valued companies post losses for years, and some disappear entirely. Anyone reading such reports should therefore always ask how the company actually plans to make money.