What is venture capital?
Venture capital is one form of financing for small businesses, startups, and growing companies that are deemed to have long-term growth potential. Investors usually give venture capital in the form of money, but they can also offer their managerial or technical expertise. Venture capital investors (called venture capitalists) are usually part of a larger venture capital (VC) firm. VC firms manage money that they raise through other sources, including family offices, high net worth individuals, and institutional investors.
Venture capital firms have experience investing in a multitude of projects, so they have a good understanding of what it takes to make a business successful. They’re looking to invest in a company with long-term growth potential and a big return on investment. Because of the stakes involved with their investment and the fact that the actual outcomes of the investment are unknown, venture capital is also sometimes referred to as risk capital or patient risk capital.
Venture capitalists usually get equity in the company in return for their investment. This means they get a say in major company decisions and will be able to influence the direction of the company. They likely won’t want to be involved in day-to-day operations, but they’ll expect to get a seat on your Board of Directors.
Read more: Venture capitalists vs angel investors
Venture capital investment process
Timing is important for venture capitalists. Venture capital investing usually comes a little later in the company’s development than angel investing which can happen before a company even gets started. However, it comes earlier than private equity funding, which is generally used for existing companies that need additional equity as they grow.
Venture capitalists will eventually pull out of the business and collect their return. They invest in several companies, knowing that they won’t all be huge successes.
Venture capital process steps
In general, these are the steps involved in getting funding from a venture capital firm.
Step 1: Submit your business plan to VC firm
The first step to capturing the attention of a venture capitalist is to reach out to them. Venture capitalists get cold calls and emails all the time, so having a personal connection in the form of a mutual interest or connection is a good way to make sure your business plan gets seen instead of tossed aside. Your business plan should include an executive summary and information on management, market size, your competition, and your financial forecast. The valuation of your company is crucial for determining what kind of investments you can get, so spend time getting it right.
Step 2: Meet with the venture capitalists
If the VC firm thinks your business plan has potential, they’ll set up a meeting. This is when the VC firm will ask you all sorts of questions about you and your business to determine whether they think it’s a good idea to invest.
Step 3: VC conducts due dilligence
If the meeting goes well, then the venture capitalist will conduct due diligence by checking your references, evaluating your business strategy, confirming debtors and creditors, and looking into any other relevant information that you shared.
Step 4: Finalize term sheet
This is where you and the VC firm agree on terms and sign a term sheet. Once this is finalized, legal documents are finalized along with a legal due diligence. Then, you’ll have funds released to your business.
Types of venture capital
Venture capital funding can happen at any time during the business’s development, though most of it comes later on. In total, there are six stages of venture capital funding:
Stage 1: Seed funding
Low-level financing that helps an entrepreneur develop their idea and turn it into a business.
Stage 2: Start-up funding
The business is in operation but needs funds in order to meet market expenses and move their product development forward.
Stage 3: First-round financing (Series A financing)
This financing is for operational businesses that have identified their markets and have developed their products. It’s for businesses that need funds for early sales and manufacturing.
Stage 4: Second-round financing (Series B financing)
At this point in a company’s growth, it has sales but isn’t profitable. It might be breaking even but needs funds to move toward being a profitable company.
Stage 5: Third-round financing (Series C financing)
This financing is for businesses that are profitable and need funds to expand into new markets, develop new products, or acquire other companies. Companies often use series C funding to increase their valuation before an IPO.
Stage 6: Fourth-round financing
This is for companies ready to go public and is also known as bridge financing.
Venture capital investment gives businesses with long-term potential money to grow in return for equity shares in the company