How Does Venture Funding Work for Startups?
Most people pursue funding for startups by looking for resources that are closest to them. Typically, this means asking family and friends for small investments. Those who still need additional funds may turn next to angel investors, high-net-worth individuals who are willing to provide funding for small startups and entrepreneurs. Angel investors are usually family members or business associates who are willing to provide a one-time investment to help the business get started, to fund an expansion, or to get a company through a rough financial patch.
At some point in the early stages of a startup, companies often need funds to take their company to the next level. That’s where venture funding comes in. Venture capitalists specialize in risky investments in the hopes that a big win will pay off. The goal of venture funding is to get a very high return, usually in the form of an acquisition of the startup or IPO. At this stage, if business owners are fortunate enough to partner with a venture capitalist, they need to be prepared to take the money and make it grow quickly.
If this stage of the business is successful, business owners may seek Series B or Series C funding, which means the business is highly successful and ready to expand, develop new products, or acquire other businesses.
Pros of Working with Venture Capitalists
There is much cause for excitement for business owners who have the opportunity to obtain venture funding because it puts them in a position to scale big faster than they could ever do on their own. Partnering with a venture capitalist allows business owners to get their hands on fairly large amounts of funding for investment in their company.
Working with venture capitalists is not like taking a loan. Business owners don’t have any obligation to pay them back; although it’s in their best interest to do so.
Venture capitalists are well-connected on many business fronts. They will almost assuredly bring a lot of business and institutional knowledge to your company. They want your company to succeed, so they’re usually eager to hook you up with other investors and businesses—and even help you find good employees.
Cons of Working with Venture Capitalists
While there are some strong pros to working with venture funding, there are also some pretty unsavory downsides. Venture capitalists are looking for a strong return on their investment, which means business owners need to work extremely hard to prove that their company is capable of the type of growth that investors are looking for.
Perhaps what is even more significant is that business owners have to be prepared for venture capitalists to take over their company. Some venture capitalists bargain for over 50% of the company right from the start, which means they would have controlling interests in the company. At some point, the venture capitalists may move to acquire the company entirely. If your plan is to keep the company and run it yourself for the long term, using venture funding may not be your best business investment path.
How Venture Capitalism Works
A venture capitalist firm can be formed when a small number of individuals come together as a group of limited partners (LPs) to raise a large sum of money that they can use to invest in startup companies.
Limited partners are usually comprised of large institutions that work with venture capitalists to get big returns on their money. The partners have a short time frame of seven to 10 years to make investments and generate the largest return possible. The only way they can reach large returns in such a short amount of time is to invest in deals that have the potential for huge financial returns.
It goes without saying that big outcomes come with big risks. The reality is that most startups fail. Large returns on investments help venture capitalists to cover the large losses that tend to go hand in hand with startup investing.
The Venture Capitalist Approach to Investing
While it’s true that venture capitalists have access to large amounts of funding, they only look at a small number of deals in their entire lifetime. For this reason, they’re highly particular about which companies they choose to invest in. Most venture capitalists place just a few bets every year. By limiting the number of companies they work with, owners can dedicate the necessary time to ensure the companies they invest in will succeed.
Most venture capitalists won’t balk at writing a check for $5 million, which is considered a Series A investment, but they’ve been known to write checks for between $250,000 and $100 million.
Attracting the Best Candidates for Venture Capital Investment Firms
In the interest of helping your company succeed, venture capitalists tend to stick to industries they know well. Many venture capitalists are eager to entertain technology products and services because they tend to create big returns. A big win for a venture capitalist is when a company goes public or when it sells for a large sum. For every 20 investments or so, venture capitalists only get one big win.
Some businesses become successful but they don’t create huge returns on the investment.
Tips on Gaining the Attention of a Venture Capital Investment Firm
The biggest challenge in seeking venture funding is simply getting in front of them. Some venture capitalists will accept unsolicited pitches, but business owners are more likely to get an appointment if they can get in through a credible source.
It’s not advisable to pursue hundreds of venture capital investment firms at a time. It’s best to select a few that align well with your product and the industry in general.
If you can get an appointment, craft a warm, well-developed elevator pitch that includes the problem your product solves, how the product works, and how large the market is for the product. It helps to have a pitch deck with 10 to 20 PowerPoint slides with your business plan.
It’s also a good idea to create a company profile on Fundable.com. Business owners should also be prepared to provide an executive summary of two to three pages that covers things like problems and solutions, market size, competition, management teams, and financials.
Business owners who invest in board-portal software like BoardEffect will impress venture capitalists by demonstrating their commitment to protecting the company against cyberattacks. Businesses that invest in cap table management software, like EquityEffect, will also have a leg up in understanding their equity structure and be able to have more informed conversations with venture capitalists. Venture capitalists will be impressed that the company is committed to working efficiently while supporting good corporate governance.