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Key Takeaways
- Wealthy investors or firms want to put their money into startups that have long-term growth potential. This type of funding is known as venture capital and the associated investors are known as venture capitalists. It is a symbiotic strategy for startups to acquire funds in the short-term while investors get the chance to expand their wealth over time.
- Venture capitalists often invest in early-stage startups. This is a risky investment due to its illiquidity but offers the capacity to achieve substantial profits if the correct venture is selected. A venture capital firm can fund a startup by investing in stock (or even reinvesting capital gains), engaging in debentures, and/or granting conditional loans.
- To raise venture capital, you need to do many things: document your strategy (including a proposal, a business model, and a presentation), gather details about your founding team, surround yourself with experts who know more than you about raising VC money, prepare a list of target investors (including details about each of them such as existing investment status and activity level), rehearse your presentation with a supportive audience (comprising a minimum of 1 seasoned investor), undertake thorough competitor analysis, learn capitalization table management, and make sure that your ideas (and most other things about you and your business) are interesting to the VCs you are targeting.
- Venture capital certainly has many benefits: it helps startups grow (considerably), it is a source of seasoned counsel, it offers vast networking possibilities, and it imposes no unconditional repayment obligation on the startup.
- VCs are generally trustworthy; it’s also usually fast and easy to track them down while you’re preparing your list of target investors.
What is Venture Capital?
Venture capital is a type of funding instrument for startups as well as an investment option for affluent individuals and institutions. Wealthy investors or firms want to put their money into startups that have long-term growth potential. This type of funding is known as venture capital and the associated investors are known as venture capitalists. It is a symbiotic strategy for startups to acquire funds in the short term while investors get the chance to expand their wealth over time.
Venture capitalists often invest in early-stage startups. This is a risky investment due to its illiquidity but offers the capacity to achieve substantial profits if the correct venture is selected.
A venture capital firm can fund a startup by investing in stock (or even reinvesting capital gains), engaging in debentures, and/or granting conditional loans.
How to Raise Venture Capital?
Document Your Strategy
Prepare the following three documents: a) a well-thought-out business proposal, b) a 1-2-page abridged version of the business proposal and c) a presentation. Your business model should provide a company strategy, thorough market research, financial predictions, and hypotheses, as well as details about the team. Although most investors don't really read the complete proposal, the act of producing it will help you communicate your narrative more effectively and prepare for investor queries. Make sure that every fact, claim, forecast, and statement in these documents can be defended. If you aren't an excellent writer and don’t have one on your team, get the assistance of a friend or hire a professional for this task.
Prepare Your Core Squad
This part is crucial for investors; be sure to explain your credentials and experience, as well as details about who has joined the founding team now and who will most likely make the cut later. Is there any wealth or "sweat equity" in the startup for its founders? You want to show your investors that your startup has the kind of dedicated team members who can help you take the next steps towards your goal.
Surround Yourself with Experts
Whether it's directors, lawyers, auditors, sophisticated investors, or industry professionals, you would do well to surround yourself with skilled advisors who have expertise in raising VC money.
Prepare a List of Target Investors
Develop a prospective investor list based on the following criteria:
(a) Niche/industry
(b) Investment level (i.e., seed-stage, Series A, B, C, etc. )
(c) Geographical location
(d) Total funds required
(e) Portfolio firms that are equivalent or competitive
(f) Possible investor connections
Find out as much as is possible about your targeted investors' existing investment status and activity level.
Rehearse Your Presentation
Find a supportive audience (with a minimum of 1 seasoned investor) that can assist you in identifying gaps and flaws in your proposal. Practice in front of a mirror. Make sure that you have a half-minute, a 3-minute, and a 15-minute version of your presentation ready. You should be able to communicate your vision simply but clearly. When presenting your pitch, space it out so that you can work criticism and recommendations into future proposals.
Undertake a Thorough Competitive Analysis
Know your competitors and be ready to set yourself apart with your business approach. Understand that you should not claim to have any competitors, no matter how exclusive your startup niche might be.
Learn Capitalization Table Management
Ask somebody to teach you the fundamentals of a business's capitalization if you don't currently grasp this subject well. Make a comprehensive capitalization table and check out our interview with Yin Wu (founder of Pulley) to learn key pointers on cap table management. Learn who owns what percentage of your company's shares and avoid imprecise, open-ended, or murky equity pledges, such as promising somebody a percent of the startup. Be explicit about the fact that you are providing them a portion of the company as of a specific date or event and don't forget to write down your equity agreements.
Speaking of equity, our guide to issuing employee equity might be quite useful to you - perhaps as useful as our primer on co-founder equity splits.
Make sure your idea is interesting
Is your idea interesting enough to pique the curiosity of the venture capitalists you’re targeting? Even if some businesses thrive, they will never become large/successful enough to provide the types of profits that venture capitalists desire. Do you have a track record of success? Is there any customer traction? Any impressive intellectual property (perhaps with a patent)? Consider raising a limited amount of initial funds from angel investors or friends and relatives to accomplish critical milestones that would make your company more appealing to venture capital firms. Decide if you wish to obtain funds through equity or a convertible instrument.
What is the difference between venture capital and private equity?
When a number of investors make direct investment in a startup, it is known as private equity. Private equity firms usually invest in established startups that have passed their growth phase. They frequently offer funding to a struggling business. They may also acquire a startup, enhance its operations, and, afterward, resell it at a profit. The purpose of a private equity investor is to increase the value of the startup so that the investor can profit from their investment. Venture capital (VC) is a type of private equity. The fundamental distinction is that while private equity investors favor solid and well-established businesses, venture capitalists typically invest in high-growth startups to help the founders scale and turn their ideas into reality. Startups with tremendous growth potential typically receive venture financing. This form of funding is more difficult to come by and appears to be riskier, but VC investors are drawn to it because of the great profit potential in it.
Benefits of Venture Capital
Helps the Startup Grow
The startup will typically be able to grow considerably with the help of venture capital. Other means of fundraising, such as bank loans, might not allow for such healthy growth. This is because, among other reasons, bank loans demand collateral and come with strict repayment requirements. With venture capital, the financiers are willing to take a risk because they have strategic trust in the startup's long-term potential. As a result, venture capital financing is quite advantageous for startups with large initial expenditures and little experience.
Seasoned Counsel
In addition to funding, venture capital provides founders with significant assistance, knowledge, and consultation. A representative of the venture capital firm is generally assigned a seat on the startup's board of directors. This permits the venture capital firm to participate actively in the startup's management. Venture capitalists' knowledge and counsel might be particularly advantageous because they tend to have experience in creating and scaling startups. As a result, they may be able to help with developing plans and providing technical support and related resources to help a startup succeed.
Vast Networking Possibilities
Venture capitalists have a vast network of contacts In the corporate world. These relationships may be highly beneficial to the growth and success of portfolio startups. VCs may be able to assist the startup in forming fruitful relationships with potential consumers, advisors, vendors, or commercial partners.
No Repayment Obligation for the Startup
If the startup collapses or stalls, there is no responsibility for the founders to repay the venture capitalist investors. As a result, venture capital has become extremely essential for new businesses. Unlike bank loans, it does not impose a repayment obligation on the startup.
They are trustworthy
VCs are effectively regulated by government agencies. In the United States, for example, the Securities and Exchange Commission regulates venture capital firms. These firms are governed in the same way as any other type of private securities business. Additionally, because a significant number of venture capital firms are handled by financial institutions such as banks, anti-money laundering requirements may also be applicable to them. It's unusual to see a VC engage in unethical behavior.
Easy to Track VCs Down
Because VCs and investors are recorded in many databases, it is quite easy to search for and discover them. For example, by simply putting "venture capital firms" into any search engine, you could receive a long list of firms that are relevant to you.
What is the major drawback of accepting venture capital?
Loss of Control and Ownership Dilution
In exchange for shares of the company's stock, venture capitalists pour large sums of money into startups. If the startup succeeds, this investment will allow them to make a lot of money.
VCs frequently join the startup's board of directors. Through this, they are involved in the startup's decision-making process. Naturally, they will want to safeguard their capital and seek to compound it through the startup. Things might get tumultuous if the VC and the startup founders have differing viewpoints. What makes the situation potentially even trickier is that important choices for the startup could necessitate investor approval.
Redemption of Capital
A VC might elect to retrieve their capital in 3-5 years. Their main goal is generally to make money. An entrepreneur whose particular company strategy will require more time than that to deliver adequate liquidity may not be a good fit for venture financing.
Lengthy Process
The founder of an early-stage startup should first provide a strategic business plan to the VC firm, which then conducts a thorough examination of the proposal. This business strategy is then discussed in a one-on-one meeting. If the VC decides to proceed with the deal, due diligence is performed to confirm the specifics. The VC will execute a term sheet only if the due diligence is judged to be sufficient. As a result, venture capital fundraising is sometimes perceived as a lengthy process, especially when the time of early-stage founders is of the essence.
The Time Taken to Come to a Decision
Investing in venture capital entails a significant degree of risk. As a result, VCs typically take a long time to evaluate whether or not to make the actual investment. Venture capital may be a good way to get money for founders to raise funding for their startups. However, the extended time that it takes to get the final money could prove to be a more significant disadvantage than initially anticipated.
Approaching VCs can be difficult
Every day, unsolicited emails bombard VCs with a slew of investment options. As a result, many business pitches go overlooked. A mutual relationship or a close contact’s recommendation is one of the best strategies for contacting the VC you’re aiming for.
Anticipation of a High ROI
Some venture capitalists want a significant return on their investment within 3 to 5 years. If your startup would require a longer time to create a good return on investment, VC funding may not be the best option for you. The anticipation of a larger ROI might lead to the buildup of a lot of stress.
Intermittent Release of Funds
Since venture capital entails such a large sum of money, the VC investor(s) may not be able to deliver all of the cash at once. The majority of contracts demand the startup to achieve specific objectives in order to obtain the funds that it sought. This puts an excessive amount of strain on the startup to hit those milestones in a timely manner so as to “unlock” the investment.
Learn More with Us
- Is Venture Capital Right for Me?
- A Guide to Startup Venture Capital Funding
- Goalposts for Funding Rounds
- How to Raise Capital
Access our Knowledge Base for Startups.
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