Venture capital (VC) is a form of financing that funds startups and businesses in their early stage that are deemed to have high and long-term growth potential. Venture capitalists invest in these emerging companies in exchange for equity shares. This kind of financing is a form of investment rather than a loan, and this investment is high-risk.
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How Venture Capital Works
Venture capital refers to venture capitalists who invest in companies that they think have the capabilities to grow and be sold either to the public or to other larger firms in the next several years. Usually, venture capital funding is provided to businesses involved in invention and innovation industries.
If you’re just launching your business, consider other startup financing options. If you are a more established business that has a potential for rapid growth but is not willing to give part of your business’s ownership and control to the VC, you may consider revenue-based financing as an alternative option.
However, if your established business cannot meet the growth requirement of VC and revenue-based financing, or if you are not willing to pay a high rate of return, you may find SBA loans to be more suitable. To make sure that your business is suitable for venture capital, you need to take the following into consideration:
Venture Capital Requires You To Give Up Some Control
Considering venture capital funding for your business means you are willing to give up some of your company’s ownership to the VC, and that includes some control on your business. You will also be held responsible to report your business’s progress to the investors, and to answer to them in case your business does not meet its objectives.
If you do not want this kind of responsibility, and if you do not want to give up control on the business, you may consider revenue-based financing.
Your Business Has High Growth Potential
VCs want to see rapid and high growth potential in a business because this kind of investment is quite risky for them. In fact, some of venture investments do not achieve the growth potential that VC expect, while there are others who do not get their investments back at all.
This is the reason why venture capitalists are often very careful and need to find out that your company can grow 10x its annual revenue in the next couple of years.
You Can Convince Others To Buy Into Your Business
Venture capitalists want to see proof that your company is a good investment. You need to be able to show that your management team has the experience and skills to build and grow the business. You need to be able to demonstrate the opportunity in the market to change and improve how people are currently doing something.
You have to show that you can make something different that will make you excel against your competition. It is ideal to have a working prototype of the product or service that you are selling, and a proof of current demands in the market to increase your sales rapidly.
The Stages of Venture Capital
Your business will undergo different stages, and there are venture capitalists who will only focus on a certain stage in your business. We will discuss briefly these stages below.
1. Seed Stage
In the seed stage, venture capitalists help a company get started. It is often difficult to find venture capital funding in this stage because your company has no enough proof that it can grow rapidly. This is the stage where angel investors often fund the business; or startup funding with personal savings may use Rollover as Business Startups (ROBS).
2. Early Stage
In this stage, venture capitalists focus on taking a company that has already proven its concept successfully. This is the common phase where venture investors would want to join your business to help with capital funding and accelerate sales and marketing efforts.
3. Growth Stage
Your company has already started and is gaining momentum for growth. This is where venture capitalists get in the picture to ensure that your growth will zoom more rapidly. In this stage, VCs often invest more amount of money.
Venture capitalists often define their investments by the business’s cycle. Some VCs prefer to invest in companies only during startup stage, where risk is highest and so is the potential for returns. Others might want to invest only during the growth stage, where growth is visible and they only need to support its expansion until the company goes public or becomes ready to be acquired by larger firms.
Venture Capital Qualifications
Venture Capitalists typically consider investing in companies with the following qualifications:
- Has a proprietary technology or dominant position in an emerging market
- Has a rapid, steady sales growth
- With a sound and skillful management team
- Has the potential of being acquired by larger companies
Not all businesses are a good fit for venture capital funding. Businesses that just starting may look for startup financing options, while other businesses that do not have the potential for high and rapid growth may consider SBA loans.
Venture Capital Costs
Generally, VCs want two things: equity and control. Typically, a business is expected to give up around 20% to 30% of its equity to VCs. When the business becomes a hit, their equity will be worth so much more. Also, VCs will want a board seat to have a control on the business to reduce their risk.
Because venture capital funding is usually risky for the VCs, investors often expect a high rate of return, typically 50%, even higher. Other VCs can go as high as 100% to 5 or 10 times their investments, which is rather costly formost businesses.
However, although the cost of VCs are relatively high, venture capitalists can provide a large sum of capital, advice, and prestige to the company, making the expectation worth it. When a business raises money from venture capitalists, it could mean that it has huge potential for rapid growth.
Venture capital funding is a great source of business financing at the early stages of business especially if your company has a huge potential for rapid and high growth. If your business has this potential and you are willing to pay high rates of returns to the VCs, your company may be a good fit for venture capital funding. There are other financing options for startups that you may want to consider if you think your business is not yet ready for venture capital funding.
Maximum Investment Amount
$1 million - $10 million+
Typical Investment Term
5 - 10 years
Typical Interest Rates
30 - 90 days
Have a question?
VCs can give prestige to the company since they only fund those that have a high potential for growth.
VCs can provide a huge capital needed by the business, such amount that are not often available through other types of financing.
VCs are generally knowledgeable and experienced when it comes to business, and this can be used to your company’s advantage.
Businesses are expected to give them control over the company.
Costs are relatively high because VCs expect high rate of returns.
Your business must have a great potential to become a hit to be able to get VC funding.
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