Venture capital (VC) is a type of financing that is provided to help scale high-potential startup businesses. Generally, this type of financial arrangement involves pooling funds from investors in exchange for equity within the company they’re financing. As a form of private equity, it’s usually offered by venture capitalists who are experienced investors and can offer industry expertise within your business operations.
Key Takeaways:
- Venture capital is a way to secure funding for your business without taking on debt.
- Investors will have a say in the operations of your business to continue growth and profitability and ensure a return on their investment.
- There are different stages of venture capital that serve varying purposes as the business grows, known as pre-seed, seed, and early-stage funding.
How Venture Capital Works
Venture capital is a form of private equity that’s offered to startups or other early-stage businesses that need funding to scale their operations. Typically, these businesses have limited resources but a high potential for growth and can benefit from a capital injection.
Generally, businesses seeking funding can present their business plans to venture capitalists to gauge their interest in investing in their company. If a partnership takes place, the investor will practice due diligence and vet the company before proceeding with an agreement.
Once the details of the transaction have been outlined and an agreement has been reached, arrangements regarding the funding of the business, the structure of the company, and growth projections will take place.
How Venture Capital Is Repaid
Getting VC differs from traditional business loans, in that there are no collateral or repayment obligations. Instead, a business can offer stakes in equity or convertible debt in exchange for financing.
- Equity: VC firms can hold on to their shares or liquidate their holdings in a company for a profit once a company is acquired or has begun trading its shares on a public exchange.
- Convertible debt: Typically structured with a convertible note, any venture capital investments through convertible debt are repaid at a future funding or liquidity event. You issue these payments at a premium (typically 20%), and your investor has the option to receive payment in the form of cash or equity in the company. Liquidity events refer to acquisitions, subsequent fundraising rounds, or IPOs.
The Role of Venture Capitalists in Your Business
As they receive a stake in ownership, this allows investors to have some level of control over the decisions and operations of the business. Since venture capitalists are typically experienced industry professionals, their expertise can provide growth opportunities for the business, and ensure a return on investment.
Typically, at least one member of your partner VC firm will sit on your company’s board of directors, overseeing the overall strategy of your startup. Their position gives them the authority to veto any major decisions regarding company directions. They even have the power to remove you as an executive of your company. Many founders don’t realize how much authority the board of directors has over them and are surprised to find that even though they keep much of the equity, they have little power.
Who Venture Capital Is Right For
Small business venture capital can provide startup businesses with the funding they need to pursue business development and keep up with operations. It may be best suited for:
- Startups with high-growth potential: Venture capitalists will typically only invest in startups that have high-growth potential, since they want to see a return on their investment. If your business is looking to grow and can demonstrate a strong growth trajectory, it may increase your chances of securing venture capital.
- Businesses who can offer equity: In exchange for funding, you’ll have to give up a portion of control of your company. This may be beneficial for business owners looking for investors with a hands-on approach. For business owners who aren’t comfortable with providing stakes in equity, this may not be the best financing option.
- Businesses looking for industry expertise: To make sure that a business is continually growing and profitable, venture capitalists will usually offer their industry expertise to help manage your business operations. This can be beneficial to businesses that are looking for help in structuring and pursuing their business goals.
- Businesses planning for initial public offering (IPO) or acquisition: For businesses who eventually plan to take their company public or are looking to be acquired, venture capital can pave the way for growth, although it usually requires multiple funding rounds to get to this stage.
Pros & Cons of Venture Capital
| PROS | CONS |
|---|---|
| Can provide industry expertise from investors and help scale your business | Can impact your level of control in the business due to equity exchange |
| No monthly repayment requirements since there’s no debt involved | Can be difficult and competitive to find interested investors |
| Can offer networking opportunities that can lead to future funding | Can inflict high expectations to grow the business quickly |
Types of Venture Capital
There are various types of venture capital that usually revolve around the different funding stages of a growing business. These stages include the initial funding round to get the business up and running, and subsequent funding rounds known as series A, B, C & D funding. Each round has varying purposes and funding amounts specific to the needs of growing your business.
- Pre-seed funding: This takes place in the earliest stages of scaling your business, and typically is sourced during the establishment of your company.
- Seed funding: This stage usually involves the launch of your business’s product or service, and is when you’ve collected VC to upkeep operations since there’s no revenue incoming yet.
- Early stage funding: In early stage funding, this acts as a boost in capital once your business has been operating and has started generating revenue, to help further scale your business development.
Where to Get Venture Capital Funding
Venture capital is typically offered by venture capital firms, investment banks, or individual venture capitalists. To find interested investors, you’ll have to do some research to ensure you work with a qualified partner with expertise in your business industry.
When starting your search, here are some options that can connect you with potential venture capitalists:
- Online VC platforms: Online investor databases can match you with venture capitalists who are looking to invest in specific products or services. These platforms can include information based on your business preferences, such as location, industry, and capital needs. You can browse active venture capital firms in your industry by visiting Crunchbase, a provider of company insights, or asking for a referral from other entrepreneurs.
- Startup accelerator programs: There are programs specific to startup businesses that aim to provide early-stage companies with resources to help them grow. These are called either startup incubators or accelerator programs and typically require a presentation representing your business, how capital funds would be used, and how you plan to scale your business. One way to apply to accelerators is by checking out F6S, a platform that lets founders interact with investors, accelerators, incubators, and more.
- Events & networking: Making connections is one of the best ways to find applicable venture capitalists. You can network with various investors through industry events, startup competitions, or through other business owners who have obtained VC and make industry connections that can lead to both funding and learning opportunities.
Alternatives to Venture Capital Funding
If you think sourcing venture capital isn’t the right fit for your business, or you simply want to explore all of your available financing options, here are some alternative startup financing options that you can consider:
- Angel Investors: Similar to venture capitalists, angel investors are high-value individuals who provide smaller amounts of capital in the early stages of a business in exchange for convertible debt, with no monthly repayment expectations. Read our guide on how to raise angel funding to learn more.
- Rollover for Business Startups (ROBS): A ROBS allows you to access your retirement account balances tax- and penalty-free and use funds for business purposes. This form of financing isn’t considered a loan, and has no interest fees or repayment expectations. To learn more or find a provider, check out our guide on the best ROBS providers.
- Startup business loans: There are a variety of loan types and lenders that offer startup loans. Depending on your business needs, you can get a term loan, line of credit, or specialized financing like an equipment or commercial real estate loan. Our article on startup business loans can help you determine which financing option may be the best fit for your business.
- Friends & Family loan: Instead of getting a traditional business loan, you may be able to source funds from friends and family, and also get more favorable rates and terms. While there are regulations that apply, this is a less formal method of obtaining financing and can benefit businesses with limited credit history and resources. Our article on raising money from friends and family can provide you with more detailed information.
- Small business grants: You can apply for small business grants to financially supplement your business. While funding amounts can vary and competition can be tough, it can be worth the effort to apply since funds generally have no repayment expectations and can provide publicity opportunities for your business. View our guide on the best small business grants to find out if you qualify.
Frequently Asked Questions (FAQs)
Venture capital is provided by investors who are looking to invest in high potential businesses in exchange for an ownership percentage of the company. This is a debt-free way for businesses to receive a capital injection to scale their businesses. With this, investors can also provide expertise and help with managing the company to further scale the business and achieve a return on their investment.
Getting venture capital can be somewhat difficult, due to the fact that venture capitalists have specific business industries or products they are looking to invest in. There can also be quite a bit of competition to stand out within your company’s industry, along with various requirements that may be imposed by interested investors.
No. Getting venture capital is different from getting a traditional business loan, where the expectation is to repay the funds with interest. Instead of repayment, an equity exchange takes place so that the investor receives a percentage of ownership in your business. This provides incentive for the investor to help your business grow, and ensure a return on investment.
Bottom Line
Venture capital can be a good financing option for startups looking to avoid taking on debt to fund their business. In exchange for funding, businesses can offer stakes in equity rather than take out a loan. You can gain valuable expertise from the venture capitalists you work with, along with potential networking opportunities to further grow your business. That said, venture capital can oftentimes be difficult to get, as there can be a lot of competition for funding.
Now that you know what venture capital is, make sure it’s the best fit for your business and that you’re comfortable giving up a portion of your control in your company if you decide to go this route.
