Financing Your Startup Business with Venture Capital
Venture capitalists raise money from various institutional and pension fund investors to back start-up and growing companies that show strong potential to develop and to turn a profit. Venture capital firms go through a process of raising funds from foundations, endowment funds, retirement funds, corporations, and foreign investors. Similar to a mutual fund, a venture capitalist firm pools investment dollars and then looks for solid investments.
Most often, venture capitalists look for very big returns, making them more selective than angels who may invest in smaller businesses. They are devoted to raising money for new and emerging business ventures so they want to maintain a strong track record in raising fund for successful companies. Therefore, they are most often seeking to invest in companies that will grow quickly and see large profit margins.
Venture capitalists generally invest in several businesses at a time to limit their risk. Typically, they will also become involved in the business, providing their experience and expertise in the industry. This is, in part, because unlike angels who are investing their own money, the venture capitalist firm is investing the money of other people or institutions.
Like most other types of financing, venture capital is usually part of the equation. A venture capital firm may want to know that there are other sources of funding. In many cases, venture capitalists look at the long-term picture and if the business grows according to the plan, it may receive several rounds of funding. However, the business must account for how all funding has been used and follow the goals and plans set forth in accordance with the previous round(s) of financing.
There are also various types of venture capitalists. Some will focus on providing seed money for a new business venture, while others will come in only later on in the development of the business. Venture capitalists may specialize by investing in specific industries or types of businesses. They may only serve a specific geographic region or only provide funds for expansion purposes of an existing business. It is important that you research the investing criteria of a venture capital firm before approaching them.
It is also imperative that you be thouroughly prepared before meeting with such a venture capitalist. This means you will need to present a well-honed business plan and, as is the case with most potential investors, be able to provide all the difficult requests and questions surrounding the business.
These include:
- Having a clear vision of the business and being able to articulate that vision
- Understanding potential obstacles that you may encounter and having plans for dealing with such obstacles or setbacks
- Having a clear idea of how long it should take to show a profit
- Presenting a strong, experienced management team
- Providing a well-planned marketing strategy that defines your target market and how you plan to reach them
- Demonstrating enthusiasm and confidence that your business can meet any challenges and succeed against them
- Presenting a large market opportunity
- Showing proprietary technology or rights
If a venture capital firm is interested in your business, it will do its own due diligence and evaluate the background and history of the management team, the financial projections, and the market in which the business is involved. A venture capital firm might be interested in providing seed money to a new business but may hesitate if, for example, they become aware of potentially steep competition in the marketplace. All potential investors will do research to determine the validity of their investment. Venture capitalists may go farther and dig deeper since they are usually dealing in larger amounts of money and are responsible to many investors. Therefore, be ready to hand over all documentation requested, ranging from your Bylaws to recently executed contracts so that they can evaluate your business thoroughly. Click here for a sample Due Diligence Checklist used by venture capital funds.
If all goes well and a venture capitalist is interested in working with you, a term sheet will be issued. This is a proposed contract of sorts, which includes how much the venture capitalist is willing to invest, the conditions of the investment, and how the money is expected to be used. A lawyer should be present who is familiar with reviewing such term sheets and negotiating this type of deal.
