Venture capital is a type of funding that helps early-stage businesses grow and expand. It involves investing in startups with high potential for growth and profitability. This type of financing can be provided by individuals or firms who are willing to provide the necessary capital in exchange for equity ownership.
The process starts with the venture capitalist assessing the business idea, team, market size and financial projections. Once they deem it worthy, they will invest their money as well as help guide the company through its growth phase. The goal is to ultimately sell their stake in the company at a higher value than what was invested initially.
Venture capitalists often look for companies that have unique products or services, strong management teams and potential markets that are large enough to support significant growth. They generally invest larger amounts than angel investors but also expect higher returns on investment.
In short, venture capital provides startups with access to much-needed cash flow during their critical early stages of development while offering investors an opportunity to earn substantial profits on their investments if things go according to plan.
Tips for Securing Funding
When it comes to securing funding for your startup, it’s important to approach the task strategically. Here are some tips to keep in mind:
- Do your research:
Before approaching venture capitalists, make sure you understand their investment criteria and focus areas. This will help you tailor your pitch accordingly.
2. Build relationships:
Networking is key in the world of venture capital. Attend industry events, join relevant groups on social media platforms and build personal connections with potential investors.
3. Have a solid business plan:
A clear and well-thought-out business plan can go a long way when seeking funding from VCs.
4. Be realistic about valuation:
While it’s tempting to overvalue your company, doing so can backfire when seeking investment from VCs who have extensive experience valuing startups.
5. Show traction:
Investors want to see that you have made progress towards achieving your goals since launching your startup – whether that be increased revenue or user growth.
6. Consider First Raising Money from Crowd funding, Angel Investors, or Friends and Family:
Startups typically raise money in stages. The stages are commonly referred to as: seed money, Series A, Series B, and Series C.
Seed money is an early stage investment that may be just enough to get you started. You can read more about seed funding for startups and how to prepare here.
Series A investments are usually used to turn you into a more efficiently-operating business and can range from the hundreds of thousands to the low millions.
Series B, Series C, and later rounds are used for further growth and optimization as your business matures. Investments in these rounds can be measured in the tens or hundreds of millions of dollars for a successful business.
VCs generally look to invest millions of dollars at once, so this eliminates them for most seed money and many Series A rounds.
If you’re in these earlier stages, consider using other methods such as raising money from friends and families, looking for an angel investor, or turning to crowd funding. Your crowd funding options include traditional platforms (such as Kickstarter or Indiegogo) or new equity crowd funding sites that allow individuals to make small, direct equity investments in private companies (e.g., AngelList and Fundable).
7. Know How Venture Capital Firms Make Money:
VCs work in a similar manner as the mutual funds you might have in your retirement account. The VC pools investor money together and invests the lump sum in growing companies.
The fund managers make their money in two ways. One is a management fee that is typically around 2 percent of the size of the fund. The other is by taking a percentage of the returns. This is called carry and is usually set at about 20 percent. The managers don’t receive the carry until the investors receive their original money back.
The firm will seek to grow your company in a way that both makes their investors’ money and gets the managers paid.
8. Build a Team of Advisors:
By the time you reach the venture capital stage, your business will be moving faster than you can keep up with on your own. You’ll need to make many important decisions quickly that could decide the success or failure of your business. And, so, you need a good team working with you.
At this point, your team should have skilled professionals knowledgeable about the venture capital process, your general legal and accounting needs, and your specific industry. Fill in the gaps by bringing in key employees or savvy investors, or by hiring professionals on a fractional basis.
9. Learn Your Capitalization Table:
Your capitalization table identifies the owners of your company, how much they own, and what kind of shares they own. It also helps you track authorized versus issued stock, granted options versus your reserve options pool, and other unvested rights. Investors want to know exactly what they’re getting in return and if anything will potentially dilute their investment.
10. Select Your Target:
VCs often have different focuses, such as industries, geographic regions, and company sizes. For example, a smaller VC might be looking to make ten $500,000 investments, while a larger one is looking for investments in the $5 million range. Others might focus on slightly newer or slightly more established companies.
Figure out where you stand in the market so you can target VCs that are looking for companies like yours. Avoid sending email templates and instead write custom messages tailored specifically to each venture capital website with their specific preference. The National Venture Capital Associate website has more in depth information about venture capital, advice, statistics, and lists of venture capital associations.
The best approach is to find someone who can introduce you to the VC. Networking opportunities are sometimes available through alumni and business associations, or through contacts at companies in which the VC has already invested.
11. Set Your Budget:
Venture capital shouldn’t be seen as a prize or milestone on its own. It’s just one option you have for raising money for your business.
Raise venture capital only when you don’t have the funds you need to meet your next business objectives on your own. Before asking for venture capital, determine exactly how much you need to meet those objectives. Your ask should be based on that amount and not the most you think you can raise. Hang on to as much equity as you reasonably can for yourself or future funding.
12. Review the Term Sheets Carefully:
As you move into the later stages of a venture capital deal, the VC will present you with a term sheet containing the full terms of the deal. This goes into the small details beyond how much of your company they’ll own and how much they’ll invest. Think of it like the fine print when you’re buying a car but with much bigger consequences.
Some of the items that may be included in the term sheet include:
- Investor rights
- Board seats
- Option pool
- Voting rights
- Liquidation preferences
- Founder vesting schedules
- Founder revesting of shares
- Veto rights
- Preferred stock
- Convertible notes
Each individual item contains nuances that could drastically alter your rights or the true value of a potential deal. You should always have a lawyer review a term sheet and be involved in negotiations.
If a VC says a term you’re uncomfortable with is nonnegotiable, don’t be afraid to walk away. Each VC has their own way of structuring deals, and another firm may be a better fit for you.
13. Prepare for Due Diligence:
If a VC likes your initial pitch, it will conduct an exhaustive review of your business. Your financial statements, business structure, facilities, and key employees will all be under the microscope.
The purpose of due diligence is both to confirm what you said in your pitch and to dig into the smaller details that weren’t discussed in-depth at earlier meetings. By this point, you should be operating under a formal accounting system and have taken steps to comply with all legal requirements imposed on your business.
You will be given little time to correct any lingering issues before a deal falls apart, so you should begin preparing for this review well before you dive into the venture capital process.
14. Do Your Own Due Diligence:
Due diligence is a two-way street, not a roadblock to a deal. You also want to make sure a particular VC is right for you.
Even though you’ve done your initial homework, dig deeper into how the VC’s previous investments have gone. Don’t forget to look beyond the numbers to see whether founders felt they were treated fairly or were pushed out of the company. You’re looking for a partnership as much as you’re looking for funding.
15. Get Legal Assistance:
You should rely on your instincts when making business decisions, but make sure you also have the right information. Many factors will determine whether a particular move is right for you, such as your business structure, securities regulations, local laws, and any special issues impacting your industry.
If you decide to make a deal, there will also be a ton of complex legal paperwork to complete. To get help with this process as well as general advice along the way, use UpCounsel to find an attorney with experience helping growing businesses in your area. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures and Airbnb.
Raising capital for your startup can be a challenging and intimidating process, but it’s also an essential part of turning your vision into a reality. By understanding your options, doing your research, and staying focused on your goals, you can increase your chances of securing the funding you need to succeed. Good luck!