Venture capital

Venture capital investment is a great way of raising funds — for startups and companies looking to grow fast.

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What is venture capital?

With venture capital (VC ), companies can receive unsecured funds — in exchange for equity (shares in the business). Venture capital firms seek to invest in early and mid-stages companies — with the goal of a “big” (highly profitable) exit down the line (typically in a few years).

Venture capital is a form of private equity investment. It can also be seen as a source of alternative business finance — particularly when it involves things like shared earning agreements and revenue-based financing.

Although venture capital is similar to angel investing, it differs in that — VCs are generally companies (rather than individuals) that invest bigger amounts into both startups and more developed companies.

Some venture capital firms commonly sponsor business incubators.

Venture capital — considerations

Venture capital is provided to startups and developing businesses — that have the potential for rapid, long-term growth. This investment capital is usually sourced from high net worth individuals, pension funds, investment banks, corporations, government etc. As well as this investment capital — VC firms can bring valuable technical and managerial expertise to the table.

As VC funds are normally invested in businesses with little trading history — venture capital is seen as a high risk asset class. However, the potential for high returns on investment — is what makes it worthwhile to venture capitalists (VCs).

VCs aim to invest money into companies that will grow very quickly, allowing them to sell the shares they own — for massive profits in the future.

Venture capitalists may come in at different stages, of a companies development, namely — seed, early and growth stages. Seed investors help companies get started, early investors help companies with proven concepts — while growth investors provide the cash required for rapid expansion.

For startups or new business ventures — venture capital has become a popular source of funds. For companies in certain industries — VC capital can even be considered essential. Particularly where such companies have limited access to capital markets and other debt instruments.

For businesses the main downside to venture capital — is that investors commonly get a stake in the company. Depending on the agreement, as well as equity, VCs may also be given a say in business operations.

Having said this, there has been a rise in alternative venture capital — which has moved away from the traditional VC model. There are now things like online equity crowdfunding and other models — which do not pursue the typical big exits.

These other models include things like shared earnings, and the option to pay back any venture funding — through either a share of revenue or a traditional exit. These alternative models give startups more flexibility, putting less pressure on them to grow and expand — in the name of a big exit.

Although venture capital can be a great way for businesses to obtain financing, getting venture capitalists to invest in a company — can be a challenge. As well as having a startup that can scale very quickly, companies also need the right team, connections and be able to communicate their plans clearly.

How does venture capital work?

The first step that any company looking for venture capital would take, is finding a VC firm that is the best possible fit — for the startup idea. The better the fit — the higher your chances of getting the needed financing. Important things to consider include — what companies they have invested in before, what stage of funding do they prefer, does your long-term vision match the VCs and more.

Following this, you would seek to connect with the VC firm. As long as you are semi-credible, most VCs will look at your business plan. However, it would be better if you were able to get a referral — from someone on the inside.

Should the VC be interested, they would do some background research on your company and its founders. They will look into your business history, models, products, services, management and other related things.

After vetting, they may extend you a VC offer. This offer will typically be in the form of funds — in exchange for equity in your company. The structure of venture capital agreements do vary — with some being more flexible than others.

For example, some VCs will take up smaller equity — in combination with some sort of revenue sharing agreement. At this stage it is paramount that you work out a deal — that you are fully comfortable with.

Funds may be advanced all at once, or released in rounds — based on you meeting certain targets. Normally, VC firms will take active roles in your funded company — giving advice and monitoring the progress you make.

Depending on the initial agreement, venture capitalists may exit the business — after a period of time. Channels of exit include — merger, acquisition or initial public offering (IPO).

Benefits of venture capital

  • Chance to expand your business
  • Valuable guidance and expertise — from VC principals and partners
  • Gain more industry connections
  • Equity based finance — no debt obligations
  • Large amounts of money can be raised

Limitations of venture capital

  • Dilution of ownership — potentially less control
  • Takes time before funds are approved
  • Application process can be tedious
  • Cash may not be released all at once
  • May undervalue your company

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