Venture capital is normally raised in the early stages of growth for a firm, well before the company has gone public (sold its shares in the public market). Even successful, rapidly developing young companies often have needs for capital that far outstrip their profit-generating capability, their ability to borrow, or the resources of their owners. This is where the venture capitalist comes in. He or she provides funding (seed capital) with the hope that his or her capital will eventually be harvested in the form of a successful public offering of stock at some point in the future. Venture capitalists are normally overwhelmed with potential proposals for funding. The acceptance rate is lower than 1 out of 100. When the Basses of Fort Worth, the Pritzkers of Chicago, or other venture capitalists see a deal, they always have their eye out for the next Microsoft or Intel. The odds are long, but the potential payout is great. Not only do venture capitalists provide funding, but they also may share their expertise in management, marketing, finance, and so on. Some venture capitalists even specialize in certain areas such as biotechnology or computer software. Often, the financing takes place in sequential stages. This means that additional funding after the original funding will only take place if certain goals are met. These goals may relate to profitability ratios, new product development, market penetration, and so on.

The venture capitalist often provides relatively low-cost debt financing, but with the understanding that the funding carries with it the potential to participate in a major way in any successful public offering of stock in the future. While the venture capitalist may not care about owning a direct equity interest in the company while it is private, he or she wants to participate in ownership when there is a public distribution of shares. Convertibles and warrants fit very well into these investment parameters. With convertibles, the venture capitalist is able to receive interest income and enjoy a relatively high priority of claims among other suppliers of capital. At the time an equity position becomes desirable, he or she can merely convert the debt to common stock. Another alternative is to provide the venture capitalist with warrants as part of the compensation package for extending debt financing. As an incentive, the exercise price on the warrants may be set at one-fifth to one-tenth of the anticipated potential price for a public offering.

When convertibles or warrants are used in early-stage financing, one can think of the interest payments on the related debt as providing singles or doubles to the venture capitalist. What he or she is really hoping for is a grand slam home run in the form of a successful public offering that is fully subscribed to and one in which the stock continues to go up in value after the offering.

Apart from funding, what additional expertise might venture capitalists provide to the companies they invest in? What is the purpose of providing warrants to venture capitalists as part of the compensation package for debt financing? Why might a venture capitalist be interested in converting debt to common stock using convertibles? What is the ultimate aspiration for a venture capitalist investing in a company's public offering?