Venture capital funding is usually given to emerging
companies at the beginning stages of their trajectory that do not have a track
record of growth and profitability but can demonstrate that with funding they
will grow into a company that will produce high profits and thus a high return
for the investor.
These investments are seen as high risk and so they are
usually made by people or firms that have much experience in high risk
investment environments and not by regular lending institutions that refrain
from investments that have a high potential to lose all their original money.
Pro Advice:
- Venture capital can come in many forms.
- Venture Capitalists will offer their technical knowledge,
managerial expertise and financial expertise/connections
- Typically these investors will ask for a large portion of
the company.
How Does Venture Capital Work?
Venture capital firms often provide funding to young
businesses and startups.
But it’s possible for a venture capital firm to invest at a different stage of the company’s development. With that, a long-standing company standing on the edge of extreme growth would also be a good candidate for a venture capital investment. For example, Greycroft, a venture capital firm, invested in Acorns and Venmo.
The venture capital firm, and its investors, will receive
their profits when the company exits through a merger, IPO, or acquisition.
- Structure of VC firms: Venture capital firms are often
structured in the form of a partnership that purchases minority shares of
companies with growth potential.
- VC firms have a portfolio of companies: Many firms focus on
a particular industry to build a portfolio of companies within.
- The profits are split between general and limited partners:
The general partners manage the venture capital fund of limited partners, who
are the investors that put up the cash. When investment performance profits are
received, the limited partners receive 80% of the funds and the general
partners receive 20%. Typically, general partners also receive an annual
management fee of up to 2% of the invested funds.
- Venture capitalists aren’t angel investors: Venture capitalists manage other people’s money. But an angel investor is a wealthy individual that invests their own funds in startups. See what are angel investors for more details.
Stages In Venture Capital Funding
If you want to pursue venture capital funding, understanding the many stages of the process is important. Here’s a look at the process beyond the venture capital funding definition:
- Seed stage: If you have an idea for a business that can't
get off the ground without major funding, you’ll need to convince a venture
capitalist that the idea has merit. A persuasive founder will be able to
convince a VC firm to take a chance on their idea. The funds will be used to develop
the product, conduct market research, and set up a team.
- Startup stage: If you’ve already developed a prototype and
completed the necessary market research, an investor can provide the infusion
of cash necessary to market the product.
- First stage: At this point, your company is starting to
manufacture and sell the product. Even with a commercially-viable product or
service, you’ll need funding to reach your customers.
- Expansion stage: With enough demand for the product, you’ll
start to expand your offerings. But most expansions require additional funding.
- Bridge stage: In this final step, a venture capitalist can
help the company transition from a private company to a public company. This is
the end goal of all venture capitalists because big returns are possible here.
How To Get Venture Capital Funding
Now that you know what a VC is in business, you might decide that its the right fit for your business. But getting this type of financing isn’t as simple as filling out a loan application. Here’s what you need to do to pursue venture capital funding:
- Research venture capital firms: Not all VC firms are created
equally and many focus on a particular industry. With that, take the time to
research the firms that might be interested in your company. You don’t want to
waste your time trying to work with a venture capitalist that isn’t the right
fit.
- Make sure your company is ready: You don’t want to approach a VC firm until you’ve built out a business plan. Although things can always change, a detailed business plan can serve as a roadmap to your company’s future success. If your company is not yet ready you might want to look into an alternative source of funding such as microloans. See what is a microloan for more details.
- Secure a meeting: Send out requests for a meeting to the
venture capital firms you want to work with. You can set yourself apart from
the crowd with a professional note and an overview of why your company has
major growth potential.
- Build a pitch: Start by determining a fair business
valuation. Next, build out a pitch deck with professional materials designed to
convey your competency. It’s important to tailor the pitch to the specific firm
you’ll be meeting with.
- Get through the due diligence process: If a venture
capitalist wants to work with you, they’ll conduct a thorough investigation
into your company and your past. It’s important to be open and honest about
anything that could stand in the way of the deal.
- Negotiate: If you receive an offer from a VC firm, it’s
tempting to jump in headfirst. It’s likely you’ll have to part with a
significant portion of your company’s equity. So, take the time to make sure
the deal is right for your situation. Otherwise, you might regret your quick
reaction.
- Move forward with more funding: After the deal is settled,
you’ll have the funds you need to grow your business.
Tips On Getting Ready For A Meeting With Venture Capitalist
If you’ve landed a meeting with a venture capitalist, that’s just the first step. Here are some tips to help you nail the meeting:
- Form your business entity: Don’t go to the meeting without
setting up your business’ legal entity. Most venture capitalists prefer to work
with businesses that are Delaware general corporations with a C status.
- Work with a legal professional: After the initial formation,
it’s time to draft a few documents including founder stock purchase agreements,
bylaws, indemnification agreements, proprietary information agreements, and
stock certificates. The right lawyer can help you wade through these documents.
- Research your industry in relation to VCs: Is there a major
growth opportunity? Make sure to have the numbers ready to back up your claims.
- Be clear on what the VC can bring to the table: Most venture
capitalists want to utilize their skills and expertise when growing a business.
Find out what skills the investors specialize in before heading to the meeting.
- Ask questions about the firm: Don’t assume that any VC firm
is a good fit. Take the time to ask questions to decide whether or not the deal
feels like the right move for your business.
Who Is Venture Capital Funding Recommended For?
Venture capital funding isn’t the right fit for everyone. But here’s when it could be the right move for you.
- Startups in hot industries: Is there a major potential for
growth in the industry? The allure of high investment returns will draw venture
capitalists.
- Entrepreneurs with unique ideas: If you have a unique idea
that could grow very quickly, venture capital funding could be the right move.
- Entrepreneurs with a solid track record: Have you already
built and exited a successful business? Investors love working with someone
that has a proven record of business success.
- Market demand: Is there more demand for your product than
you can meet? That could mean a big chance at high returns.
If venture capital doesn’t seem like the right option for you, you could look into peer to peer lending. See what is peer to peer lending.
Pros And Cons Of Venture Capital Funding
All funding types come with advantages and disadvantages.
Let’s look at the pros and cons of venture capital funding.
Starting with the pros:
- Access to the funding you need: Venture capital can be the
infusion of cash your business needs.
- Professional guidance often available: Most venture
capitalists provide expertise and advice as you grow your business.
- Long-term funding potential: Although not always the case,
many venture capital firms will build long-term relationships with successful
entrepreneurs.
Now for the cons:
- Competitive space: It can be challenging to obtain funding
through this option based on the extensive competition.
- Low chance of funding: Less than 10% of presented plans
actually receive funding.
- Must give up some equity: If you want to maintain full control
over your business, this is not the right move for you.