The way in which Venture Capital Works meant for Start-Ups together with Small Businesses
April 8, 2021 Business
With almost unlimited opportunities the advancement in technology is creating over the past two decades, many startups and small businesses today have a tendency to seek for capital that might bring their dream business to success. While there is a wide range of financial sources that they’ll tap on, many of these entrepreneurs are hesitant in borrowing money from banks and financial lenders due to the risks involve. But good thing is that they’ve found an excellent alternative and that is by raising venture capital from the venture capitalists or VCs.
Venture capital is that amount of cash that VCs will invest in trade of ownership in a business which include a stake in equity and exclusive rights in running the business. Putting it in another way, venture capital is that funding made available from venture capital firms to companies with high potential for growth.
Venture capitalists are those investors who have the capacity and interest to finance certain forms of business. Venture capital firms fund management services, on the other hand, are registered financial institutions with expertise in raising money from wealthy individuals, companies and private investors – the venture capitalists. VC firm, therefore, could be the mediator between venture capitalists and capital seekers.
Because VCs are selective investors, venture capital is not for several businesses. Just like the filing of bank loan or requesting a line of credit, you will need to show proofs that your business has high potential for growth, particularly during the very first three years of operation. VCs will look for your company plan and they will scrutinize your financial projections. To qualify on the very first round of funding (or seed round), you’ve to ensure that you’ve that business plan well-written and that your management team is fully ready for that business pitch.
Because VCs would be the more knowledgeable entrepreneurs, they want to ensure that they’ll improve Return on Investment (ROI) as well as a fair share in the business’s equity. The mere fact that venture capitalism is a high-risk-high-return investment, intelligent investing is definitely the standard type of trade. A formal negotiation involving the fund seekers and the venture capital firm sets everything inside their proper order. It starts with pre-money valuation of the company seeking for capital. Next, VC firm would then decide on how much venture capital are they going to put in. Both parties must agree with the share of equity each will receive. Generally, VCs get a share of equity including 10% to 50%.
The funding lifecycle typically takes 3 to 7 years and could involve 3 to 4 rounds of funding. From startup and growth, to expansion and public listing, venture capitalists is there to assist the company. VCs can harvest the returns on the investments typically after 3 years and eventually earn higher returns when the company goes public in the 5th year onward.
The odds of failing are always there. But VC firms’strategy would be to invest on 5 to 10 high-growth potential companies. Economists call this strategy of VCs the “law of averages” where investors genuinely believe that large profits of several will even out the little loses of many.
Any business seeking for capital must ensure that their business is bankable. That’s, before approaching a VC firm, they must be confident enough that their business idea is innovative, disruptive and profitable. Like some other investors, venture capitalists desire to harvest the fruits of their investments in due time. They’re expecting 20% to 40% ROI in a year. Apart from the venture capital, VCs also share their management and technical skills in shaping the direction of the business. Over time, the venture capital market has become the driver of growth for thousands of startups and small businesses round the world.